1 


1.  is  0''E  on  the  last  r 


SOUTHERN  BRANCH, 

I'NIVERSITY  OF  CALIFORNIA, 

LIBRARY, 

iLOS  ANGELES,  CALIF. 


Digitized  by  the  Internet  Archive 
in  2008 


https://archive.org/details/budgetarycontrolOOmcki 


Budgetary  Control 


By 

JAMES  O.  McKINSEY,  A.M.,  LL.B. 

Certified  Public  Accountant;  Member  of  the 
firm  of  Frazer  &  Torbet ;  Assistant  Professor 
of  Accounting,  University  of  Chicago 


Second  Printing 


488H5 

NEW  YORK 
THE  RONALD  PRESS  COMPANY 
1923 


Copyright,  1922,  by 
The  Ronald  Press  Company 


All  Rights  Reserved 


PREFACE 

Although  much  has  been  written  of  budgetary  control 
as  applied  to  particular  phases  of  a  business,  this  is  the  first 
attempt,  so  far  as  the  author  is  aware,  to  present  the  sub- 
ject as  a  whole,  and  cover  the  entire  budgetary  program. 
It  is  to  be  regarded  as  an  effort  to  state  clearly  the  problems 
involved,  rather  than  to  offer  full  solutions.  It  is  hoped 
that  the  discussion  will  stimulate  thought,  and  constructive 
criticism  will  be  gladly  received. 

One  obvious  difficulty  has  been  the  problem  of  what  to 
include  and  what  to  omit.    The  budgetary  procedure  in- 
^  .  volves  administrative  policies  on  the  one  hand,  and  admin- 
^  istrative  routine  on  the  other.    The  discussion  might  easily 
cover  the  whole  field  of  business  administration,  ranging 
over  a  wide  variety  of  topics  about  which  no  one  individual 
can  be  expected  to  have  expert  knowledge.    In  the  present 
work,  however,  the  reader  is  addressed  throughout,  not  as  a 
technical  expert,  but  rather  as  a  student  of  the  broad  prob- 
^  lem  of  administration.    The  advertising  man,  for  example, 
1  may  be  aided  in  handling  his  own  problems  through  under- 
r  standing  the  method  of  applying  budgetary  control  to  the 
operations  of  all  other  departments  of  the  business,  as  ex- 
plained in  the  other  chapters  of  the  book.    So  with  the  other 
departmental  executives ;  it  is  hoped  that  each  of  them  will 
be  helped  by  a  comprehensive  picture  of  the  problem  as  a 
whole.    The  discussion  has  been  kept  sufficiently  elemen- 
tary, it  is  believed,  to  be  easily  understandable  by  those  who 
are  not  experts  on  the  technical  subjects  discussed. 

With  this  thought  in  mind,  there  has  been  no  effort  to 
prescribe  an  arbitrary  procedure.  In  some  cases,  assump- 
tions have  been  made  and  definite  procedures  discussed,  but 

iii 


iv 


PREFACE 


only  for  the  purpose  of  making  the  treatment  concrete ;  the 
definite  procedures  given  are  intended  to  be  suggestive  only. 
Similarly,  the  various  forms  given  are  merely  indicative. 
All  of  them  have  been  used  by  the  author  at  some  time  in 
his  professional  practice,  but  he  by  no  means  regards  them 
as  standard  forms.  He  has  found  it  necessary  to  design 
forms  to  meet  each  particular  case. 

Finally,  no  attempt  has  been  made  to  discuss  in  detail 
the  many  problems  which  may  arise  in  the  installation  and 
operation  of  budgetary  control.  To  do  so  would  be  to  make 
the  volume  less  useful  to  those  for  whom  it  is  primarily  in- 
tended. It  is  thought  that  the  reader  who  has  a  compre- 
hensive picture  of  the  entire  problem  will  be  able  to  make 
his  own  applications  and  to  work  out  the  special  adjust- 
ments required  for  his  own  situation. 

The  text  is  based  primarily  on  the  rather  wide  experience 
of  the  author  in  professional  work,  but  material  assistance 
has  been  received  from  various  business  men,  accountants, 
and  instructors.  Particular  acknowledgment  is  due  to  the 
following:  Mr.  W.  V.  Lindblom,  executi\'e  in  charge  of  the 
budgetary  procedure  of  the  Walworth  Manufacturing  Com- 
pany, and  Mr.  Albert  S.  Keister,  Lecturer  on  Business 
Finance,  University  of  Chicago,  who  have  read  all  the 
manuscript  and  given  many  useful  suggestions;  Mr.  N.  L. 
McCully,  executive  in  charge  of  the  budgetary  procedure  of 
the  Lewis  Manufacturing  Company,  who  prepared  the 
chart  on  budgetary  procedure  given  in  Chapter  XXIII ;  and 
Mr.  George  E.  Frazer,  C.P.A.,  the  author's  partner,  to 
whose  counsel  and  assistance  the  author  is  especially  in- 
debted. . 

James  O.  McKinsey 

Chicago,  Illinois, 
June  20,  1922 


CONTENTS 


Chapter  Page 

I   The  Meaning  of  Budgetary  Control   3 

II    The  Need  for  Budgetary  Control   12 

III  Preliminary  Steps  in  Installation   28 

IV  Organization  for  Budgetary  Control   43 

V   The  Sales  Budget   54 

VI    The  Sales  Budget  (Continued)   71 

VII   The  Selling  Expense  Budget   87 

VIII   The  Advertising  Budget    106 

IX   The  Production  Budget   124 

X   The  Materials  Budget   145 

XI   The  Labor  Budget   165 

XII   The  Welfare  Expense  Budget   178 

XIII  The  Manufacturing  Expense  Budget   188 

XIV  The  Purchases  Budget   210 

XV   The  Purchases  Budget  (Continued)   228 

XVI   The  Plant  and  Equipment  Budget   245 

XVII    The  Plant  and  Equipment  Budget  (Continued)  .  .  .  261 

XVIII    The  Expense  Budgets   273 

XIX   The  Financial  Budget   295 

XX   The  Financial  Budget  (Continued)   316 

XXI   The  Estimated  Balance  Sheet   333 

XXII   The  Estimated  Statement  of  Profit  and  Loss.  .  .  359 

XXIII  Manual  of  Budgetary  Procedure   374 

XXIV  Administrative  Reports   396 

XXV  Advantages  and  Limitations  of  Budgetary  Control  416 

XXVI    Budgetary   Control  for  Non-Commercial  Enter- 
prises   425 

Appendix  A — The  Budget  and  Accounting  Act   439 

B — Administrative  Code  for  the  State  of  Ohio.  .  450 

C — A  Trust  Company  Budget  System    456 

V 


ILLUSTRATIONS 


Figure  Page 

1.  Chart  Showing  Corporate  Form  of  Organization  .   ........  21 

2.  Form  Showing  Factory  Requirements  for  Use  in  Preparing  Sales 

Estimate   73 

3.  SeUing  Expense  Budget   103 

4.  Report  on  Selling  Expense  Budget   103 

5.  Advertising  Appropriation  Report   117 

6.  Advertising  Appropriation  Report  (monthly  cumulative)   121 

7.  Advertising  Expenditures  Report   122 

8.  Monthly  Finished  Stock  Budget  Report   141 

9.  Balance  of  Stores  Sheet   153 

10.  Materials  Budget   161 

11.  Periodic  Materials  Budget  Report   161 

12.  Labor  Budget   175 

13.  Monthly  Labor  Budget  Report   175  ' 

14.  Welfare  Expense  Budget   185 

15.  Monthly  Welfare  Expense  Report   185 

16.  Manufacturing  Expense  Budget   205 

17.  Monthly  Manufacturing  Expense  Report   205 

18.  Schedule  of  Deliveries  to  Stock   221 

19.  Monthly  Report  on  Purchases  Budget   225 

20.  Estimate  of  Purchases  Disbursements   231 

21.  Showing  Merchandise  Plan  of  Each  Department  of  a  Department 

Store   239 

22.  Plant  Ledger   254 

23.  Plant  and  Equipment  Budget   263 

24.  Monthly  Report  on  Appropriations  for  Plant  and  Equipment.   .   .  269 

25.  Organization  Chart  for  a  Manufacturing  Business   275 

26.  Another  Form  of  Organization  for  a  Manufacturing  Business  .   .   .  277 

27.  Expense  Budget   292 

28.  Monthly  Expense  Appropriation  Report   293 

29.  Graph  Showing  Accumulated  Sales  and  Collcc'  ions   304 

30.  Estimate  of  Cash  Receipts   308 

31.  Simple  Estimate  of  Cash  Disbursements   311 

32.  More  Elaborate  Estimate  of  Cash  Disbursements   313 

33.  Summary  of  Financial  Requirements   317 

34.  Financial  Program  for  Bank  Loans   318 

35.  Monthly  Collections  Report   321 

36.  Monthly  Cash  Receipts  Report   322 

37.  Monthly  Cash  Disbursements  Report   323 

38.  Balance  Sheet   339 

35.  Comparative  Balance  Sheet,  with  Preliminary  Estimate   351 

40.  Comparative  Statement  of  Profit  and  Loss,  with  Preliminary  Esti- 

mate   363 

41.  Comparison  of  Actual  and  Estimated  Balance  Sheets   369 

42.  Comparison  of  Actual  and  Estimated  Statements  of  Profit  and  Loss  371 

43.  Chart  of  Budget  Procedure  (opposite)  394 

44.  Monthly  Sales  Report   402 

vii 


viii  ILLUSTRATIONS 

45.  Monthly  Selling  Expense  Report  403 

46.  Monthly  Net  Profits  Report  405 

47.  Monthly  Stock  Report  407 

48.  Monthly  Comparative  Summary  408-40;) 

49.  Monthly  Summary  of  Operations  412 

50.  Monthly  Group  Pound  Cost  413 

51.  Monthly  Factory  Inventories  Report  414 

52.  Departmental  Salary  Budget  of  a  University  434-435 

A  Trust  Company  Budget  System  (Appendix  C) 

Monthly  Summary  of  Expenses  459 

Monthly  Expenses  of  Securing  Business  460 

Monthly  Expenses  of  Transacting  Business — Main  Office  .  .  .  461-462 

Yearly  Summary  of  Expenses  463 

Request  for  Appropriation  464 

Yearly  Appropriation  Sheet  465 


Budgetary  Control 


CHAPTER  I 


THE  MEANING  OF  BUDGETARY  CONTROL 


Planning  of  Business  Operations 

That  comprehensive  planning  is  necessary  for  efficient 
administration  may  be  regarded  as  an  axiom  of  the  present- 
day  philosophy  of  business  administration.  Business 
executives  have  come  to  realize  that  they  can  perform 
properly  the  tasks  of  today  only  if  they  have  already 
planned  those  tasks  yesterday,  and  planned  also  the  tasks 
of  tomorrow.  There  are  many  who  do  not  yet  plan 
scientifically,  but  there  are  few  who  will  deny  the  merits 
of  the  system. 

The  planning  which  may  be  done  in  connection  with  any 
particular  business  may  be  classified  into  three  broad  over- 
lapping groups : 

I.  That  which  deals  with  the  operations  of  the  separate  depart- 
ments, such  as  production,  sales,  and  finance.  Such  planning 
has  been  described  loosely  in  the  past,  as  "industrial  engineer- 
i  ing-" 


\/2.  That  which  deals  with  the  coordination  of  the  operations  of  the 
several  departments  to  the  end  that  a  well-formulated  program 
may  be  made,  for  the  business  as  a  whole.  Such  planning 
may  well  be  termed  "budgetary  control." 
3.  That  which  deals  with  the  determination  of  future  conditions  as 
reflected  in  the  business  cycle  and  the  shaping  of  the  plans  of 
the  business  to  meet  these  conditions.  Such  planning  is  known 
as  "forecasting"  or  "business  predicting." 

While  the  discussion  in  the  following  pages  is  restricted 
primarily  to  a  consideration  of  planning  of  the  second  kind, 
it  must  be  realized  of  course  that  these  various  kinds  of 
plans  are  all  very  closely  related  and  must  be  coordinated  if 


3 


4 


BUDGETARY  CONTROL 


proper  results  are  to  be  obtained.  The  budgetary  plans  are 
vitally  affected  by  the  business  cycle,  and  the  departmental 
plans  are  equally  affected  by  the  budgetary  plan.  The 
reader  will  notice  that  in  the  following  pages  it  will  be  neces- 
sary to  discuss  to  some  extent  all  three  kinds  of  planning. 

Popular  Conception  of  Budgetary  Control 

In  the  past,  budgetary  control  has  been  considered  pri- 
marily in  connection  with  governmental  units.  There  has 
/  been  much  discussion  of  the  "budgets "  of  cities  and  states, 
and  during  recent  years  much  interest  has  been  manifested 
in  the  budget  of  the  national  government.  This  interest 
has  been  greatly  increased  by  the  passage  of  the  National 
Budget  Act  and  the  submission  to  Congress  of  the  first 
budget  prepared  under  this  act.  The  budgets  of  govern- 
mental units  are  discussed  frequently  in  the  daily  press  and 
by  aspirants  for  political  office,  and  are  thus  called  constantly 
to  the  attention  of  the  public.  As  a  consequence  many 
people  have  come  to  think  of  budgetary  control  as  an  instru- 
ment for  governmental  administration.  Not  only  is  this  the 
popular  view  but  practically  all  the  literature  on  budgetary 
control  is  confined  to  a  discussion  of  governmental  budgets. 

Although  practically  all  people  who  have  given  thought 
to  the  subject  will  admit  that  there  should  be  budgetary 
control  of  public  finances,  very  few  have  thought  of  budg- 
etary control  with  reference  to  the  individual  business  unit. 
It  is  thepurpose  of  these  chapters  to  showthat  theprinciples 
of  budgetary  control  are  as  applicable  to  the  individual 
business  unit  as  to  the  governmental  unit,  and  to  explain 
the  method  by  which  these  principles  may  be  applied.  As 
a  first  step  it  is  necessary  to  see  (i)  what  budgetary  control 
is,  and  (2)  why  it  is  needed  in  business  administration.  The 
present  chapter  and  the  chapter  immediately  following  will 
be  devoted  to  a  consideration  of  these  topics. 


THE  MEANING  OF  BUDGETARY  CONTROL  5 


Procedure  for  Budgetary  Control 

-Pfobably  the  be&fe^v¥ay40  show  "what  budgetary  control 
us"  ia  to  outline  how  it  operates.  The  procedure  to  be  fol- 
lowed by  a  business  firm  in  the  installation  and  operation  of 
budgetary  control  will  of  necessity  vary,  depending  pri- 
marily on  the  organization  of  the  business  and  the  nature  of 
its  operations.  A  pirssible  procedure,  stated  briefly  and  in 
■-^outline  form,  is  as  follows:.     V  ^   >  i  r- 

^  Each  department  prepares  an  estimate  of  its  activi- 
ties for  the  budget  period.  The  method  of  stating  these 
activities  depends  on  the  nature  of  the  operations  of  the  de- 
partment, the  sales  department  stating  the  sales  it  expects 
to  make  and  the  estimated  expenses  it  will  incur  in  making 
these  sales ;  the  production  department  stating  the  estimated 
production  for  the  period  and  the  estimated  requirements 
in  materials,  labor,  and  manufacturing  expenses  to  meet  this 
estimate;  the  service  departments,  such  as  the  personnel 
department,  the  traffic  department,  the  accounting  depart- 
ment, and  the  office  manager's  department,  stating  the  esti- 
mated expenditures  of  their  departments.  Because  of  the 
interdependence  of  these  departments,  some  will  need  to 
use  the  estimates  of  other  departments  in  making  their  own 
estimates.  For  instance,  the  production  department  must 
know  the  estimated  sales  before  it  can  estimate  the  produc- 
tion necessary  to  meet  the  sales  demands;  the  treasurer 
must  know  the  plans  of  all  the  departments  before  he  can 
estimate  his  cash  receipts  and  cash  disbursements.  Con- 
sequently a  procedure  must  be  set  up  which  provides  for  a 
proper  scheduling  of  the  estimates  with  reference  to  prepa- 
ration and  distribution. 

a.  The  departmental  heads  will  transmit  the  depart- 
mental estimates  to  an  executive  who  has  supervision  of  the 
budgetary  procedure.  Sometimes  the  controller  acts  in 
this  capacity,  while  in  many  cases  the  duty  is  delegated  to  a 


6 


BUDGETARY  CONTROL 


member  of  the  staff  of  the  general  manager  or  president. 
Since-^frany  bnsinesses  do  not  have  a  controller,  itr  will  b"^ 
assumed  -during  the  present  discussion  that  an  assistant  to- 
the  president  acts  in  this  capacity.  This  official  combines 
the  estimates  of  all  the  departments  into  a  proposed  finan- 
cial budget  for  the  business.  In  preparing  this  estimate  he 
will  be  assisted  by  the  treasurer,  though  in  some  cases  this 
budget  is  prepared  by  the  treasurer  alone.  The  proposed 
financial  budget  should  show  the  estimated  receipts  from 
all  sources  and  the  estimated  expenditures  by  all  depart- 
ments of  the  business. 

5.  The  executive  in  charge  of  the  budget  procedure 
makes  a  comparison  between  the  estimated  receipts  and  the 
estimated  expenditures  as  shown  by  the  proposed  budget. 
If  the  estimated  expenditures  exceed  the  estimated  receipts, 
one  of  the  following  courses  of  action  must  be  taken : 

(a)  The  departmental  expenditures  may  be  reduced. 
In  making  such  reductions  a  problem  arises  due  to  the  fact 
that  the  reduction  of  expenditures  may  result  in  a  reduction 
of  receipts.  For  instance,  if  the  expenditures  of  the  adver- 
tising department  are  reduced,  this  may  result  in  a  reduction 
of  sales,  with  a  consequent  reduction  of  receipts  from  col- 
lections. In  the  same  manner,  a  reduction  of  the  expendi- 
tures of  the  production  department  may  result  in  a  reduc- 
tion of  production,  with  a  consequent  lack  of  goods  to  meet 
sales  demands  which  will  result  in  a  reduction  of  receipts 
from  sales.  Care  must  be  taken,  therefore,  in  the  reduc- 
tion of  expenditures  to  see  that  receipts  are  not  reduced 
more  than  proportionately. 

(b)  Additional  receipts  may  be  secured.  It  may  be 
possible  by  speeding  up  operations  and  securing  more  effi- 
cient administration  to  secure  additional  receipts  without 
incurring  a  proportionate  increase  of  expenditures. 

(c)  Additional  capital  may  be  secured.    If  it  is  not 


THE  MEANING  OF  BUDGETARY  CONTROL  7 


deemed  wise  to  reduce  expenditures,  plans  must  be  made 
to  secure  additional  capital  with  which  to  finance  the  excess 
of  expenditures  over  receipts.  It  is  understood,  of  course, 
that  this  condition  cannot  continue  for  long,  otherwise  the 
business  will  find  it  necessary  to  liquidate. 

The  executive  in  charge  of  the  budgetary  procedure  may 
make  recommendations  with  reference  to  possible  pro- 
cedures, but  he  is  usually  not  invested  with  authority  to 
determine  the  plans  to  be  followed. 

4^  The  executive  in  charge  of  the  budgetary  procedure 
prepares  from  the  departmental  estimates  an  estimated 
balance  sheet  and  an  estimated  statement  of  profit  and 
loss,  showing  respectively  the  anticipated  financial  condi- 
tion at  the  end  of  the  budget  period  and  the  anticipated 
result  of  the  operations  of  the  period. 

5«  The  departmental  estimates,  together  with  the  pro- 
posed financial  budget,  and  the  estimated  financial  state- 
ments, are  submitted  by  the  executive  in  charge  of  the  budg- 
etary procedure  to  a  budget  committee,  composed  of  the 
principal  executives  of  the  company  and  presided  over  by 
the  president.  This  committee  considers  the  proposed  esti- 
mates and  makes  such  revisions  as  it  thinks  necessary.  In 
case  the  proposed  budgets  involve  important  changes  in  the 
company's  policy,  or  require  the  securing  of  additional 
capital  for  a  material  amount,  it  may  be  necessary  to  submit 
them  to  the  board  of  directors  for  consideration,  -kidcqd, 
in  some  businesses  all  budgetary  plans  are  submitted  to  the 
board  of  directors  for  approval.  After  the  proposed  esti- 
mates have  been  approved,  they  constitute  the  working 
program  for  the  budget  period.  The  budgets  as  adopted 
set  limits  upon  the  expenditures  of  all  the  departments,  and 
these  limits  cannot  be  exceeded  without  the  permission  of 
the  budget  committee.  The  budgets  also  set  up  standards 
of  performance  for  certain  departments.    For  instance,  the 


8 


BUDGETARY  CONTROL 


sales  budget  states  the  sales  that  are  to  be  made  by  the  sales 
department,  and  the  production  budget  states  the  estimated 
production  of  the  production  department. 

-6.  Each  department  makes  plans  which  will  enable  it  to 
carry  out  its  program  as  outlined  by  its  budget.  For  in- 
stance, the  advertising  department  makes  contracts  for 
advertising  space;  the  sales  department  sets  quotas  for  its 
salesmen;  the  production  department  sets  up  schedules  of 
production. 

Records  are  established  so  that  the  performance  of 
each  department  may  be  properly  recorded  and  comparisons 
made  between  the  estimated  and  the  actual  performance. 
Periodic  reports,  showing  a  comparison  between  the  estimat- 
ed and  the  actual  performance  of  each  department  for  the 
budget  period,  are  made  to  the  executive  in  charge  of  the 
budgetary  procedure  and  are  by  him  transmitted  to  the 
budget  committee  and  in  some  cases  to  the  board  of  direc- 
tors. On  the  basis  of  these  reports  the  budget  committee 
or  board  of  directors  may  make  such  revisions  of  the  budg- 
etary program  as  it  may  deem  desirable. 

Essential  Features 

The  foregoing  procedure  is  intended  to  be  suggestive 
only.  Each  organization  must  adopt  a  procedure  which  is 
fitted  to  its  particular  needs.  The  purpose  of  the  foregoing 
outline  is  to  indicate  what  budgetary  control  is  by  suggest- 
ing how  it  operates.  From  this  outline  it  can  be  seen  that 
budgetary  control  involves  the  following: 

1.  The  statement  of  the  plans  of  all  the  departments  of  the  business 

for  a  certain  period  of  time  in  the  form  of  estimates. 

2.  The  coordination  of  these  estimates  into  a  well-balanced  pro- 

gram for  the  business  as  a  whole. 

3.  The  preparation  of  reports  showing  a  comparison  between  the 

actual  and  the  estimated  performance,  and  the  revision  of  the 
original  plans  when  these  reports  show  that  such  a  revision  is 
necessary. 


'1 


THE  MEANING  OF  BUDGETARY  CONTROL  9 


Budgetary  Control  Not  a  New  Idea 

All  businesses  practice  budgetary  control  to  a  greater 
or  lesser  degree  although  many  of  them  do  not  realize  the 
fact.  The  newsboy  estimates  his  probable  sales  before  mak- 
ing his  purchases,  and  every  business  man  must  do  like- 
wise if  he  is  to  continue  to  operate  long.  Even  the  farmer, 
who  usually  scorns  the  use  of  formal  methods  of  control, 
estimates  the  probable  returns  from  land  used  for  various 
kinds  of  crops  and  the  cost  of  producing  each,  and  on  this 
basis  decides  upon  the  crop  which  he  will  plant.  During 
the  war  the  Red  Cross,  the  Y.M.C.A.,  and  Liberty  Loan 
committees  used  the  budgetary  idea  in  their  "drives"  by 
setting  up  quotas  for  each  territory.  These  quotas  were 
based  on  estimates  of  the  sales  possibilities  in  these  terri- 
tories. Budgets  for  governmental  units  have  been  in  use 
for  many  years,  and  the  "family  budget"  has  long  been  a 
matter  of  discussion. 

Many  business  firms  which  deny  that  they  operate  a 
budgetary  program  will  be  found  to  make  and  use  estimates. 
In  this  connection  the  author  recalls  a  visit  he  made  to  the 
merchandise  manager  of  a  large  wholesale  store  several 
years  ago.  This  executive  derided  the  idea  of  preparing  a 
sales  estimate  and  stated  that  he  did  not  care  to  discuss 
such  an  academic  question.  A  few  minutes  later  the  author 
inquired  if  the  merchandise  manager  permitted  his  buyers 
to  use  their  own  judgment  in  deciding  on  the  quantity  of 
goods  to  purchase.  He  emphatically  replied  that  to  permit 
the  buyers  to  purchase  all  they  desired  would  bankrupt  the 
firm  in  six  months.  In  response  to  the  request  to  explain 
how  the  buyers'  purchases  were  controlled,  he  stated  that 
the  executives  of  the  firm  first  obtained  the  average  sales 
for  the  past  three  years  and  added  to  this  average  the  per- 
centage of  increase  which  they  expected  during  the  next 
year.    After  they  determined  in  this  manner  their  "ex- 


10 


BUDGETARY  CONTROL 


pected  "  sales,  they  "calculated  "  the  purchases  necessary  to 
meet  these  sales  and  instructed  the  buyers  accordingly.  It 
took  the  author  some  minutes  to  show  the  manager  that  his 
firm  was  preparing  both  a  sales  estimate  and  a  purchases 
estimate.  Further  investigation  showed  that  it  was  the 
practice  of  the  treasurer  of  the  company  to  obtain  a  copy  of 
the  sales  estimate  and  purchase  estimate  and  to  use  these  as 
a  means  of  making  estimates  of  cash  receipts  and  disburse- 
ments. In  other  words,  the  company  had  an  informal  and 
imperfect  system  of  budgetary  control. 

Similar  investigations  will  show  that  all  other  profitable 
businesses  make  plans  for  future  operations,  and  however 
informal  these  plans  may  be,  they  are  in  essence  budgetary 
control. 

Modern  Tendency  Towards  Budgetary  Control 

Modern  business  administration  tends  more  and  more 
to  become  a  standardized  routine.  In  a  large  organization 
such  standardization  is  essential  to  the  maintenance  of  a  uni- 
fied business  policy  and  to  the  coordination  of  the  activities 
of  the  several  departments ;  and  coordination  means  subordi- 
nation to  a  common  head.  Business  men  are  gradually 
coming  to  realize  that  this  can  best  be  accomplished  by  the 
formulation  of  plans  submitted  for  approval  in  black  and 
white,  if  indeed  coordination  can  ever  be  accomplished  in 
any  other  way  for  a  great  length  of  time.  Not  that  plans 
have  not  always  been  made,  but  they  have  commonly  been 
carried  around  in  someone's  head.  Because  of  the  increase, 
however,  in  the  volume  of  business  performed  by  the  typical 
industrial  unit,  with  the  corresponding  complexity  in  busi- 
ness organization,  it  is  coming  to  be  less  and  less  possible  to 
maintain  a  business  organization  that  depends  upon  the 
intuitive  faculties  of  a  single  individual  developed  by  years 
of  experience,  faculties  which  perish  with  the  individual. 


THE  MEANING  OF  BUDGETARY  CONTROL  II 


The  organization  must  be  independent  of  any  single  indi- 
vidual in  it.  All  of  which  goes  to  show  that  there  should  be 
some  systematic  method  of  gathering  information  trom  the 
past  and  formulating  on  this  basis  plans  for  the  future,  and 
of  subsequently  reporting  how  these  plans  have  been  carried 
out.  Such  an  accounting  and  statistical  organization  we 
may  call  a  budget  system. 


CHAPTER  II 


THE  NEED  FOR  BUDGETARY  CONTROL 

Why  Budgetary  Control  Is  Needed 

In  the  preceding  chapter  it  has  been  explained  that 
budgetary  control  has  long  been  practiced  in  an  informal 
way  but  that  only  in  recent  years  has  it  been  introduced  as 
a  formal  and  comprehensive  procedure.  In  fact  the  firms 
are  largely  in  the  minority  which  have  formally  adopted 
budgetary  control  at  the  present  time.  It  is  the  belief  of 
the  author  that  the  delay  of  business  firms  to  adopt  budg- 
etary control  as  a  definite  part  of  their  administrative 
methods  is  due  to  one  of  two  causes :  Either  they  do  not 
fully  realize  its  need,  or  they  do  not  understand  how  to 
install  and  operate  it. 

It  is  the  purpose  of  the  present  chapter  to  explain  its 
need  as  an  instrument  of  administration,  while  the  remain- 
ing chapters  of  this  book  are  devoted  to  an  explanation  of 
its  installation  and  operation. 

Budgetary  control  is  urgently  needed  in  administrative 
control  for  two  purposes : 

1 .  As  a  means  of  coordinating  the  activities  of  the  various  functional 

departments. 

2.  As  a  basis  for  centralized  executive  control. 

Perhaps  its  use  for  these  purposes  can  best  be  shown  by 
sketching  the  method  by  which  administrative  control  is 
exercised  in  the  modern  type  of  business  organization,  the 
problems  which  arise  therefrom,  and  the  need  for  a  compre- 
hensive method  of  planning  ahead  as  a  basis  for  solving  these 
problems.  Much  that  is  said  in  the  remainder  of  this  chap- 
ter, though  perhaps  more  or  less  familiar  to  the  reader,  is 

12 


THE  NEED  FOR  BUDGETARY  CONTROL 


13 


stated  here  in  order  to  present  a  comprehensive  picture  of 
the  problems  which  give  rise  to  a  need  of  budgetary  control. 

Interdependence  of  Business  Activities 

It  is  the  author's  experience  that  executives  often  be- 
come so  engrossed  with  what  they  regard  as  the  larger 
administrative  policies  of  their  business,  that  they  fail  to 
give  sufficient  attention  to  many  of  the  administrative 
problems  to  realize  their  significance.  They  are  easily  im- 
pressed with  the  value  of  a  sales  campaign  which  will  result 
in  a  large  increase  in  the  volume  of  sales,  but  they  may  fail 
to  realize  the  importance  of  working  out  methods  by  which 
to  coordinate  the  sales  campaign  with  the  production  pro- 
gram so  that  the  goods  sold  will  be  ready  for  delivery  at  the 
proper  time.  They  are  keenly  interested  in  the  enlargement 
of  manufacturing  facilities  and  the  increase  of  production, 
but  may  fail  to  realize  the  significance  of  maintaining  a  care- 
ful check  on  inventory  to  avoid  the  accumulation  of  unsal- 
able merchandise. 

It  is  worth  while  for  the  executive  to  make  a  comprehen- 
sive survey  of  the  w^hole  problem  of  administrative  control 
from  time  to  time  to  see  that  he  is  not  overemphasizing 
some  phases  of  the  problem  at  the  expense  of  others.  If 
this  chapter  serves  to  impress  upon  the  reader  the  inter- 
dependence of  all  the  activities  of  a  business,  it  will  have 
served  a  useful  purpose  regardless  of  his  reaction  to  the 
argument  presented  in  behalf  of  the  need  for  budgetary  con- 
trol as  a  means  of  coordinating  these  activities. 

Functional  Activities — Their  Coordination 

The  operations  of  businesses  vary  widely  and  the  varia- 
tions in  operations  produce  a  divergence  in  organization,  but 
in  every  business  there  are  certain  functional  groups  of  activi- 
ties which  must  be  performed.    These  functions  are: 


14 


BUDGETARY  CONTROL 


1 .  The  sales  function 

2.  The  production  or  purchasing  function 

3.  The  personnel  function 

4.  The  finance  function 

5.  The  standard  and  record  function 

Since  these  functions  are  found  combined  in  a  single  business 
unit,  it  is  fair  to  suppose  that  there  must  be  a  close  relation- 
ship between  them.  A  very  brief  study  will  show  that  there 
is  such  a  close  interrelation  that  it  is  impossible  to  perform 
one  of  them  unless  the  others  are  also  being  properly  per- 
formed. It  is  true  that  some  businesses  emphasize  one  of 
these  functions  and  other  businesses  emphasize  another, 
but  in  no  business  can  any  of  these  functions  be  safely 
neglected.  A  few  illustrations  of  the  interrelationship  will 
make  this  clear. 

Balancing  Production  and  Sales 

Goods  are  purchased  or  produced  in  order  to  be  sold. 
It  is  unwise  and  unprofitable  to  purchase  or  produce  more 
goods  than  can  be  sold  within  a  reasonable  time  after  their 
purchase  or  production.  To  do  so  results  in  tying  up  capi- 
tal in  a  non-income  producing  investment,  for  excess  inven- 
tories yield  no  profit.  A  second  danger  arising  from  this 
procedure  is  the  deterioration  which  may  take  place  in  the 
surplus  stock  due  to  time  or  obsolescence.  It  is  obvious, 
therefore,  that  wise  administration  will  take  into  considera- 
tion sales  expectancies  in  planning  purchases  or  production. 
The  failure  to  limit  purchases  and  production  to  correspond 
with  sales  possibilities  has  caused  many  firms  heavy  losses 
during  recent  years. 

On  the  other  hand,  it  is  unwise  to  sell  goods  in  excess  of 
the  possibilities  of  supply.  To  sell  more  than  can  be  pur- 
chased or  produced  leads  to  an  unnecessary  expense  both  in 
securing  the  sale  and  in  handling  the  inevitable  complaints 


THE  NEED  FOR  BUDGETARY  CONTROL 


15 


which  arise  from  failure  to  fill  orders.  An  additional  loss 
may  arise  from  the  ill-will  of  the  disappointed  customer.  It 
is  better  to  refuse  an  order  in  the  beginning  than  to  accept 
the  order  and  fail  to  satisfy  it.  Many  firms  lost  prestige  by 
such  actions  during  the  years  191 8  and  191 9.  It  is  necessary, 
therefore,  to  consider  production  or  purchasing  possibilities 
in  planning  the  sales  campaign.  In  other  words,  the  sales 
function  and  the  production  or  purchasing  function  are  so 
closely  interrelated  and  interdependent  that  they  must  be 
considered  jointly  in  planning  executive  policies. 

Planning  for  Equipment  and  Personnel 

Not  only  must  sales  and  production  be  correlated,  but 
this  correlation  must  be  planned  sufficiently  in  advance  of 
the  time  when  it  is  to  be  effected  to  make  possible  the  secur- 
ing of  the  necessary  equipment  and  personnel  to  produce 
the  goods  required.  In  a  manufacturing  business  plant  and 
equipment  are  essential  to  the  production  of  goods,  and  in 
considering  increased  production  the  possible  increase  in 
plant  and  equipment  requirements  resulting  therefrom  must 
be  taken  into  account.  But  the  quantity  of  production  is 
determined  by  the  volume  of  sales;  so  in  the  end  the  sales 
campaign  determines  the  plant  and  equipment  program. 
The  relation  between  these  two  functions  can  be  easily  seen. 
Loss  will  result  from  the  sale  of  more  goods  than  the  present 
equipment  cau  produce  or  than  it  is  possible  or  profitable  to 
purchase  equipment  to  produce.  In  this  connection  three 
questions  must  be  asked: 

1.  Can  the  desired  amount  of  goods  be  produced  with  the  present 

plant  and  equipment? 

2.  If  not,  can  additional  plant  and  equipment  be  secured  in  time  to 

produce  goods  to  supply  the  present  demand? 

3.  If  so,  can  such  plant  and  equipment  be  secured  and  operated 

profitably? 


i6 


BUDGETARY  CONTROL 


It  is  equally  unwise  to  secure  plant  and  equipment  beyond 
that  needed  to  satisfy  the  present  or  the  anticipated  demands 
of  customers.  Consequently  the  plant  and  equipment  pro- 
gram is  closely  related  to  both  the  sales  and  production 
programs. 

But  equipment  cannot  be  operated  without  workers  and 
it  is  necessary  to  know  the  production  requirements  suffi- 
ciently in  advance  of  the  time  of  their  fulfilment  to  make 
possible  the  securing  of  the  necessary  amount  of  personnel. 
Where  skilled  labor  is  employed  the  securing  of  the  proper 
personnel  is  a  problem  of  major  importance. 

Planning  of  Finances 

The  making  of  sales,  the  producing  of  goods,  and  the 
securing  of  equipment  and  personnel,  all  involve  a!ti  expend- 
iture of  funds.  All  these  operations  must  be  financed  and 
they  can  be  carried  on  only  to  the  extent  to  which  the  finan- 
cial resources  of  the  business  will  permit.  It  is  unwise 
indeed  for  a  business  to  plan  a  sales  campaign  with  the  con- 
sequent production  requirements  without  considering  the 
financial  possibilities  of  the  business.  A  lack  of  coordination 
of  the  sales  and  production  programs  may  lead  to  loss,  but  a 
lack  of  coordination  of  the  various  departmental  programs 
of  the  business  with  its  financial  program  will  lead  to  bank- 
ruptcy. 

Coordination — Special  Problems 

The  foregoing  illustrations  point  out  the  interrelation- 
ship of  the  primary  functions  of  the  business  and  show  the 
necessity  for  their  correlation.  But  in  the  securing  of  this 
correlation  many  things  must  be  considered.  For  instance, 
emphasis  has  been  placed  upon  the  desirability  of  not  pro- 
ducing beyond  sales  requirements  because  of  the  consequent 
loss  arising  from  the  capital  invested  and  the  possible  de- 


THE  NEED  FOR  BUDGETARY  CONTROL 


17 


terioration  of  the  goods.  There  may  be  other  factors,  how- 
ever, which  make  it  desirable  to  produce  beyond  sales  ca- 
pacity for  a  certain  period  of  time.  For  instance,  if  the  sales 
fluctuate  from  period  to  period,  it  may  not  be  desirable  to 
have  the  production  fluctuate  accordingly.  There  are  sev- 
eral reasons  for  this,  one  of  the  principal  being  the  problem 
of  maintaining  a  proper  labor  supply  if  wide  fluctuations  in 
production  take  place.  If  production  fluctuates  it  is  neces- 
sary to  discharge  laborers  whom  it  may  be  difficult  to  replace 
later,  especially  in  the  case  of  skilled  labor,  or  it  is  necessary 
to  retain  laborers  not  employed  for  full  time,  which  is  unde- 
sirable and  uneconomical.  It  may  be  preferable  to  main- 
tain a  unifonn  production  and  thereby  accumulate  in  a 
period  of  slack  sales  an  inventory  which  may  be  used  to 
meet  the  excess  demands  during  the  rush  period.  The  loss 
of  the  excess  capital  tied  up  in  the  inventory  may  be  less 
than  the  loss  which  would  result  from  fluctuating  produc- 
tion. This  is  but  one  illustration  of  the  many  problems 
which  arise  in  planning  coordination  of  the  operations  of 
the  functional  departments.  Many  more  will  undoubtedly 
occur  to  the  reader. 

Cooperation  among  Functional  Officers 

From  the  few  illustrations  given,  the  interrelation  of  the 
various  functions  of  the  business  should  be  evident  and  the 
necessity  for  the  coordination  of  these  functions  should  be 
apparent.  But  business  administration  can  be  discussed 
only  in  terms  of  business  organization,  and  ''functions"  of 
the  business  can  be  discussed  only  in  terms  of  the  "function- 
aries "  who  are  responsible  for  them.  The  discussion  of  the 
coordination  of  functions,  therefore,  resolves  itself  into  a 
discussion  of  the  coordination  of  functionaries,  and  a  brief 
study  of  the  prevailing  conditions  in  large  business  estab- 
lishments will  show  that  such  coordination  is  the  most 
2 


I8 


BUDGETARY  CONTROL 


urgent  need  for  effective  business  organization  at  the  present 
time.  A  conservative  estimate  would  attribute  a  majority 
of  the  business  failures  of  the  present  time  to  a  lack  of  co- 
ordination of  the  functions  of  the  business  due  to  a  lack  of 
cooperation  on  the  part  of  the  functional  officers.  That  this 
lack  of  cooperation  is  not  intentional  and  is  due  primarily  to 
a  lack  of  information  which  would  make  such  cooperation 
possible,  does  not  change  the  situation. 

Reason  for  Present  Lack  of  Coordination 

It  is  quite  easy  to  see  how  the  present  situation  came 
about.  When  the  business  enterprise  was  small,  with  a 
simple  organization  and  its  activities  local,  the  owner,  who 
was  also  the  manager,  was  able  to  exercise  direct  control  of 
all  the  functions  of  the  business.  He  acted  as  the  executive 
head  of  each  of  the  functional  departments;  he  was  sales 
manager,  production  manager,  treasurer,  and  controller, 
all  in  one.  Because  of  this  condition  he  was  able  to  bring 
about  the  proper  correlation  without  difficulty.  In  his  ca- 
pacity of  sales  manager  he  knew  the  sales  which  he  estimated 
possible,  so  that  he  knew  what  purchases  to  make  when  he 
was  acting  as  merchandise  manager  or  purchasing  agent. 
As  treasurer  he  knew  the  funds  which  were  available  so  that 
he  could  make  his  sales  and  purchasing  plans  accordingly. 

When  the  business  unit  increased  in  size  and  its  organiza- 
tion became  more  complex,  the  executive  was  forced  to 
delegate  certain  of  his  duties  to  assistants,  and  the  present 
plan  of  functional  organization  developed,  with  a  separate 
executive  in  charge  of  each  function.  The  change  in  condi- 
tions is  apparent.  The  sales  manager  devotes  his  entire 
time,  thought,  and  energy  to  the  securing  of  sales,  and  he 
has  no  direct  contact  with  the  production  department.  The 
production  manager  has  become  engrossed  in  the  problems 
of  production  and  has  little  or  no  means  of  becoming 


THE  NEED  FOR  BUDGETARY  CONTROL 


19 


familiar  with  the  operations  of  the  sales  department.  The 
treasurer  secures  the  needed  funds  as  best  he  can  and  has 
little  information  upon  which  to  make  his  plans.  And  thus 
the  coordination  which  formerly  was  brought  about  by  the 
centralization  of  control  in  the  hands  of  the  chief  executive 
is  lacking. 

Mere  Study  of  Past  Records  Inadequate 

During  the  past  few  years  the  functional  staff  officers  of 
many  large  businesses  have  realized  the  necessity  for  a  co- 
ordination of  the  activities  of  the  various  departments  of  a 
business  and  have  attempted  to  bring  about  this  coordina- 
tion by  studying  past  results  and  trying  to  correct  the  worst 
evils  which  were  revealed.  For  instance,  the  production 
manager  may  find  that  on  certain  articles  large  inventories 
have  been  carried,  so  that  he  plans  to  cut  down  the  produc- 
tion of  these  articles  during  the  coming  year,  thereby  reduc- 
ing the  inventories.  The  treasurer  may  find  that  during 
certain  months  his  bank  balances  are  very  low  because  of 
the  demand  on  the  part  of  the  purchasing  or  production  de- 
partment for  funds,  consequently  he  may  plan  to  increase 
his  bank  loans  at  that  time  during  the  coming  year.  In  the 
same  manner  each  department  may  study  its  past  activities 
and  plan  to  correct  the  difficulties  of  the  past.  In  some 
cases  the  departmental  heads  may  go  farther  and  study  the 
past  operations  of  the  other  departments  so  as  to  see  the 
cause  for  the  difficulties  incurred  in  their  own  department. 

This  method  of  attacking  the  problem  accomplishes 
some  results;  but  even  if  carried  out  very  completely  it 
usually  is  subject  to  two  serious  objections: 

I.  It  is  basing  future  plans  on  past  results  and  not  taking  into  con- 
sideration possible  changes.  This  is  almost  sure  to  lead  to 
inaccuracies,  since  a  business  does  not  remain  stationary;  it 
either  advances  or  goes  backward. 


20 


BUDGETARY  CONTROL 


2.  It  is  a  negative  rather  than  a  positive  program.  It  plans  to  try  to 
remo\e  the  difficulties  of  last  year;  its  goal  is  to  try  to  do  this 
year  what  it  should  have  done  last  year.  It  is  only  an  attempt 
to  reach  a  past  goal,  not  an  attempt  to  reach  a  new  goal  which 
should  have  been  set  for  this  year. 

New  Method  Needed 

It  is  contended,  therefore,  that  a  new  method  and  a  new 
poHcy  is  needed,  different  from  that  followed  by  many  firms 
at  present,  a  policy  which  will  provide  correlation  and  com- 
pel progress.  Such  a  policy  will  involve  dealing  with  future 
plans  rather  than  with  past  results,  although  plans  must  of 
necessity  be  formed  in  the  light  of  results.  Administrative 
control  necessitates  the  use  of  estimates.  The  past  is  gone 
and  cannot  be  changed.  It  is  only  future  operations  over 
which  control  can  be  exercised. 

If  the  departmental  estimates  are  to  be  used  efficiently 
and  effectively,  it  is  necessary  that  a  procedure  be  developed 
for  their  preparation,  coordination,  and  operation.  This 
procedure  when  established  constitutes  budgetary  control. 

Centralization  of  Executive  Control 

If  efficient  administration  is  to  be  accomplished,  it  is 
necessary  to  provide  not  only  for  the  making  of  plans  to 
secure  coordination  of  departmental  activities,  but  also  for 
administrative  control  of  these  activities  so  that  the  plans 
made  will  be  carried  out.  The  tendency  in  business  admin- 
istration during  the  past  half  century  has  been  towards 
centralization  of  control  in  the  hands  of  a  few  executives  and 
the  delegation  of  duties  by  these  to  subordinates  who  are 
responsible  to  the  primary  executives  for  the  performance 
of  the  tasks  thus  delegated.  This  method  has  important 
advantages,  but  it  also  gives  rise  to  certain  significant  prob- 
lems. In  ofder  to  see  the  nature  of  these  problems  and  the 
need  of  budgetary  control  in  their  solution,  let  us  sketch 


THE  NEED  FOR  BUDGETARY  CONTROL  21 


briefly  the  method  of  exercising  administrative  control  in  a 
typical  organization. 

Although  the  tendency  during  the  past  several  years 
has  been  towards  the  centralization  of  administrative  con- 
trol, the  number  of  people  who  exercise  influence  in  the 
administration  of  the  typical  business  is  quite  large.  The 
ultimate  control  of  a  business  is  with  the  owners,  but  in  the 
modem  corporate  enterprise  their  control  in  the  main  is 
exercised  only  indirectly.  Most  of  their  authority  is  dele- 
gated to  a  board  of  directors,  who  in  turn  delegate  a  large 
part  of  their  authority  to  the  general  ofiicers  of  the  corpora- 
tion.   The  general  oflicers  in  turn  entrust  the  execution  of 


Figure  l.    Chart  Showing  Corporate  Form  of  Organization 


many  of  the  policies  of  the  business  to  subordinates,  and 
these  subordinates  employ  the  services  of  assistants  who 
are  directly  in  contact  with  the  workers.  Such  a  form  of 
organization  may  be  shown  graphically  as  in  Figure  I . 

From  the  foregoing  graph  it  can  be  seen  that  in  the  cor- 
porate enterprise  executive  control  is  exercised  through  the 
medium  of  a  number  of  groups,  cooperating  in  the  perform- 
ance of  the  administrative  function.  As  showing  the  prob- 
lems involved  in  securing  this  cooperation,  a  brief  account  is 
given  below  of  the  degree  of  control  exercised  by  each  group. 

Control  Exercised  by  Owners 

In  the  corporate  type  of  business  organization  the  own- 
ership is  vested  in  the  stockholders.    Legally  the  executive 


22 


BUDGETARY  CONTROL 


control  also  is  vested  in  the  stockholders.  As  a  matter  of 
practice  they  exercise  this  control  very  indirectly.  The 
stockholders  pass  upon  only  a  few  of  the  policies  of  the  busi- 
ness, the  remainder  being  left  to  the  jurisdiction  of  the  board 
of  directors  which  is  chosen  by  the  stockholders.  The  direct 
control  of  the  stockholders  is  usually  limited  to  the  follow- 
ing: 

1.  Protection  of  Property  Interest.  The  stock- 
holder invests  in  the  corporation  for  two  purposes:  (a)  to 
secure  the  preservation  of  his  capital,  and  (b)  to  secure  an 
income  from  the  use  of  the  capital  in  the  business.  He  de- 
sires reports  which  will  show  that  his  property  interest  is 
being  protected,  and  in  case  he  realizes  that  it  is  being  im- 
paired, he  may  exercise  his  right  to  direct  actively  the  opera- 
tions of  the  business.  Of  course,  such  action  is  possible 
only  where  there  is  a  community  of  interest  with  conse- 
quent cooperation  of  a  majority  of  the  stockholders. 

2.  Maintenance  OF  Dividend  Rate.  As  stated  in  the 
preceding  paragraph,  the  stockholder  desires  to  obtain  an 
income  from  the  use  of  his  property  in  the  operation  of  the 
business.  This  income  he  obtains  by  means  of  the  dividends 
which  are  declared  by  the  board  of  directors.  He  desires 
consequently  that  the  dividend  rate  be  sufficiently  high  to 
afford  him  a  proper  return  on  his  investment,  and  he  desires 
that  this  dividend  rate  be  maintained  regularly  if  possible. 
He  is  especially  sensitive  to  a  lowering  of  the  dividend  rate 
or  the  passing  of  a  dividend  payment.  He  desires,  there- 
fore, to  be  consulted  about  a  change  of  policies  which  will 
affect  the  dividend  rate.  The  chief  interest  of  most  stock- 
holders in  the  board  of  directors  is  in  the  question  of  its 
ability  to  protect  their  property  interests  and  to  maintain  a 
fair  and  adequate  rate  of  dividend.  So  long  as  this  is  accom- 
plished, the  stockholder  does  not  seek  to  interfere  in  the 
administration  of  the  corporation. 


THE  NEED  FOR  BUDGETARY  CONTROL 


23 


3.  Financing  of  Extensions.  If  extensions  are  to  be 
made  on  a  large  scale,  it  may  be  necessary  to  appeal  to  the 
stockholders  to  contribute  additional  capital  or  to  obtain 
their  permission  for  the  issuance  of  additional  stockor  bonds. 
In  either  case  the  consent  of  the  stockholders  should  be 
obtained  by  the  board  of  directors,  although  in  the  case  of 
issuing  bonds  the  stockholders'  approval  is  often  only  formal, 
since  the  board  of  directors  works  out  the  plan  and  submits 
it  for  approval.  It  is  within  the  province  of  the  stockholders 
to  reject  such  plan,  but  this  authority  is  exercised  rarely. 

Control  by  Board  of  Directors 

The  preceding  discussion  has  emphasized  the  fact  that 
the  stockholders  delegate  most  of  their  powers  of  control  to 
the  board  of  directors.  The  board  of  directors,  although 
they  are  responsible  for  the  administration  of  the  business, 
do  not  as  directors  participate  in  such  administration.  They 
content  themselves  with  outlining  the  general  policies  to  be 
followed  and  then  delegate  the  execution  of  these  policies  to 
the  general  ofhcers  of  the  business.  The  method  by  which 
the  board  of  directors  exercises  control  may  be  indicated  by 
the  following: 

1.  They  select  the  general  officers  of  the  company  and  delegate  to 

them  certain  administrative  duties. 

2.  They  outline  the  general  policies  of  the  business  lor  the  guidance 

of  these  executives,  to  the  end  that  the  desires  of  the  stock- 
holders may  be  realized;  that  is,  that  their  property  interests 
be  protected  and  a  reasonable  dividend  rate  maintained.  To 
this  end  they  may  set  up  a  dividend  rate  which  is  to  be  main- 
tained, and  judge  the  efficiency  of  the  general  officers  by  their 
ability  to  make  possible  the  maintenance  of  this  rate. 

3.  They  consider  and  approve,  modify,  or  reject  the  general  plans 

submitted  by  the  general  officers.  Such  plans  include  the 
estimates  or  budgets  which  the  general  officers  present  to  show 
their  proposed  accomplishment  during  the  coming  period. 


24 


BUDGETARY  CONTROL 


4.  They  recelv'e  reports  from  the  executives  of  the  business  which 

show  the  degree  of  success  they  have  attained  in  carrying  out 
the  plans  which  have  previously  been  approved.  Such  reports, 
if  properly  prepared,  show  the  success  of  each  principal  execu- 
tive, as  well  as  the  success  which  has  attended  the  efforts  of 
the  executive  staff  as  a  whole. 

5.  They  award  bonuses  or  increases  of  salaries  to  the  executives  on 

the  basis  of  their  performance,  and  thus  encourage  efficiency 
and  initiative. 

Such  are  the  duties  of  the  board  of  directors  in  most 
cases.  In  a  corporation  where  the  general  officers  of  the 
corporation  are  members  of  the  board,  they  may  exercise  a 
more  direct  control  than  that  indicated.  It  is  questionable, 
however,  whether  in  this  case  the  general  officers  are  not 
acting  in  their  capacity  as  executives  rather  than  as  direc- 
tors. It  is  not  feasible  or  desirable  to  consider  here  in  detail 
the  administrative  functions  of  the  board  of  directors.  It 
is  sufficient  for  our  purposes  to  see  that  the  execution  of  the 
administrative  policies  of  the  business  is  left  in  the  main  to 
the  general  officers  of  the  business. 

Control  through  General  Officers 

As  indicated  by  Figure  i ,  it  is  customary  to  have  in  each 
business  a  chief  executive  who  is  responsible  for  the  admin- 
istration of  the  business.  In  a  corporation  this  executive  is 
usually  the  president,  although  in  some  cases  the  president 
may  be  subordinate  to  the  chairman  of  the  board  of  direc- 
tors, when  the  latter  assumes  active  executive  duties.  For 
the  purposes  of  this  discussion  we  will  assume  that  the  presi- 
dent is  the  chief  executive  officer. 

In  a  small  business  the  president  may  supervise  and 
direct  all  of  the  administrative  functions.  In  a  business  of 
any  considerable  size  this  is  impossible  and  it  is  necessary 
to  employ  other  officers  to  assist  in  the  formulation  and 
execution  of  the  executive  policies  of  the  business.  The 


THE  NEED  FOR  BUDGETARY  CONTROL 


25 


number  of  such  officers  who  may  be  employed  and  the  duties 
which  they  may  perform  will  depend  to  a  considerable  ex- 
tent on  the  nature  of  the  operations  of  the  business  and 
consequently  on  the  administrative  functions  which  must 
be  subject  to  executive  supervision.  On  a  previous  page 
it  has  been  explained  that  the  primary  administrative  func- 
tions are: 

1.  The  sales  function 

2.  The  production  function 

3.  The  purchasing  function 

4.  The  personnel  function 

5.  The  finance^unction 

6.  The  standard  and  record  function 

In  a  business  of  sufficient  size  to  make  advisable  a  func- 
tional organization  of  the  administrative  personnel,  there  is 
an  executive  head  for  each  of  the  foregoing  functions  and 
therefore  we  have  the  following  general  officers: 

1.  Sales  manager 

2.  Production  manager 

3.  Purchasing  manager  (often  termed  purchasing  agent) 

4.  Personnel  manager 

5.  Financial  manager  (usually  termed  the  treasurer) 

6.  Standard  and  record  manager  (usually  termed  the  controller) 

The  foregoing  list  of  functional  managers  who  assist  the 
president  or  the  general  manager  in  the  formulation  and 
execution  of  the  policies  of  a  business  is  intended  to  be  sug- 
gestive rather  than  inclusive.  The  ones  mentioned  are  those 
which  are  needed  to  supervise  and  control  the  functions 
common  to  all  businesses. 

Control  Exercised  by  Junior  Executives 

As  indicated  by  Figure  I,  the  general  officers  delegate  a 
considerable  part  of  their  administrative  duties  to  the  sub- 
ordinate or  junior  executives.    No  definite  statement  can 


26 


BUDGETARY  CONTROL 


be  made  with  reference  to  the  duties  to  be  performed  by 
these  officers,  but  the  modern  tendency  is  to  delegate  as 
many  details  as  possible  so  that  the  general  officers  may 
have  more  time  to  give  to  a  consideration  of  general  plans 
and  policies.  The  junior  officers  delegate  duties  to  their 
assistants,  and  these  in  turn  give  instructions  to  the  workers, 
both  manual  and  clerical. 

Result  of  the  Delegation  of  Administrative  Duties 

The  foregoing  sketchy  outline  of  the  process  by  which 
administrative  control  is  exercised  in  the  typical  business 
organization  shows  that  it  involves  a  continual  delegation  of 
duties  from  one  administrative  group  to  another.  The 
stockholders  delegate  duties  to  directors,  the  directors  dele- 
gate duties  to  the  general  officers,  the  general  officers  dele- 
gate duties  to  subordinate  officers,  and  so  on.  Experience 
has  shown  that  in  such  an  organization,  if  rational  control  is 
to  be  exercised,  it  is  essential  that  there  be  available  informa- 
tion of  three  kinds : 

1.  Information  which  will  serve  as  a  basis  for  the  formulation  of  the 

general  policies  of  the  business  and  for  the  delegation  by  each 
group  of  certain  duties  to  the  next  subordinate  group. 

2.  Information  which  will  enable  each  group  to  perform  properly 

the  duties  delegated  to  it  and  to  coordinate  its  activities  with 
those  of  all  the  other  groups. 

3.  Information  which  will  enable  each  group  to  judge  as  to  the  effi- 

ciency with  which  the  duties  delegated  by  it  have  been  per- 
formed by  the  subordinate  group  to  which  they  were  delegated. 

To  obtain  this  information  in  an  accurate  and  compre- 
hensive manner  it  is  necessary 

1.  To  maintain  accounting  and  statistical  records  which  will  show 

past  performance. 

2.  To  use  the  information  shown  by  the  accounting  and  statistical 

records  as  a  basis  for  preparing  estimates  of  future  per- 
formance. 


THE  NEED  FOR  BUDGETARY  CONTROL 


27 


3.  To  obtain  from  the  accounting  and  statistical  records  the  current 

performance. 

4.  To  prepare  reports  showing  a  comparison  between  current,  past, 

and  estimated  perfonnance. 

Judging  by  Past  Performance  and  by  Contemplated  Plans 

In  the  past,  executives  have  relied  primarily  on  informa- 
tion with  reference  to  current  and  past  performance.  They 
have  judged  current  results  by  past  results.  They  have 
left  their  subordinates  to  use  their  initiative  to  a  large  extent 
and  rewarded  them  on  the  basis  of  the  success  which  they 
attained.  To  some  extent  this  practice  is  still  followed. 
As  pointed  out  in  the  discussion  of  the  control  exercised  by 
the  stockholders,  they  judge  the  success  of  the  directors  by 
their  ability  to  maintain  the  capital  of  the  corporation  and 
to  earn  a  satisfactory  income.  It  is  typical  of  them  to  con- 
sider the  accomplished  results  of  the  directors'  administra- 
tion rather  than  the  anticipated  results  of  their  contemplated 
plans.  Many  stockholders  have  followed  this  custom  to 
their  sorrow  and  have  found  their  investment  dissipated  by 
actions  of  the  directors  which  they  could  not  correct  after 
they  had  been  consummated.  In  some  cases  directors 
depend  on  reports  showing  the  results  of  the  actions  of  the 
general  officers  instead  of  insisting  on  reports  showing  their 
contemplated  plans  and  the  anticipated  results  of  these 
plans.  Officers  in  turn  sometimes  follow  the  same  policy  in 
dealing  with  subordinates. 

Gradually,  however,  stockholders,  directors,  and  general 
officers  are  coming  to  realize  that  effective  administration 
requires  the  making  of  plans  and  that  the  formulation  of 
plans  necessitates  the  use  of  estimates.  The  preparation 
and  enforcement  of  these  estimates  is  the  purpose  of  the 
budgetary  program  as  outlined  in  the  following  chapters. 


CHAPTER  III 


PRELIMINARY  STEPS  IN  INSTALLATION 

First  Steps  Towards  Budgetary  Control  ^ 

Many  business  fimis  which  reaHze  the  need  for  budg- 
etary control  are  at  a  loss  how  to  proceed  to  effect  its  installa- 
tion. Often  an  attempt  is  made  to  commence  its  operation 
without  giving  proper  thought  to  the  formulation  of  a  com- 
prehensive procedure  for  its  execution.  In  these  cases 
undesirable  consequences  almost  invariably  result.  In 
working  out  the  budgetary  procedure  it  is  necessary  that  a 
logical  sequence  be  followed  so  that  no  part  of  the  program 
may  be  delayed  because  of  the  failure  of  any  other  part. 

Executives  have  a  tendency  to  think  that  the  depart- 
mental estimates  are  the  essence  of  the  budgetary  program 
and  consequently  start  the  preparation  of  sales  estimates, 
production  estimates,  and  financial  estimates  without  first 
working  out  a  procedure  to  govern  their  preparation  and 
use.  Consequently  a  great  amount  of  data  is  collected  as 
the  result  of  much  labor  and  expense  but  is  found  to  be  of 
little  use  because  it  is  not  in  form  to  be  correlated  and  also 
because  the  executives  do  not  understand  the  service  which 
may  be  obtained  from  it.  They  are  apt  to  feel,  therefore, 
that  the  budgetary  program  entails  useless  expense  and 
they  seek  to  secure  its  abandonment. 

It  is  necessary  for  the  success  of  the  budgetary  plans  that 
certain  preliminary  problems  be  settled  before  the  budgetary 
process  is  commenced.  Every  professional  accountant  and 
industrial  engineer  who  has  given  consideration  to  methods 
of  administrative  control  has  seen  many  well-intended  ad- 
ministrative plans  fail  because  attention  had  not  been  given 
to  the  problems  to  which  they  necessarily  give  rise,  or  to  the 

28 


PRELIMINARY  STEPS  IN  INSTALLATION 


29 


method  of  meeting  these  problems.  This  situation  is  par- 
ticularly apt  to  occur  in  an  attempt  to  install  budgetary- 
control,  because  most  executives  have  not  given  careful 
thought  to  its  operation  and  consequently  are  not  apt  to 
foresee  the  problems  to  which  it  will  give  rise. 

It  is  the  purpose  of  this  chapter  to  discuss  the  first  steps 
which  are  involved  in  the  installation  and  operation  of 
budgetary  control.  The  following  topics  will  be  discussed 
in  order: 

1.  Length  of  the  budget  period 

2.  Responsibility  for  the  preparation  of  estimates 

3.  Responsibility  for  reports 

4.  Method  of  enforcing  budgets 

5.  Cooperation  of  executives  and  employees 

Length  of  the  Budget  Period 

One  of  the  first  questions  which  arise  in  connection  with 
the  installation  of  budgetary  control  is,  What  shall  be  the 
length  of  the  budget  period?  Little  or  nothing  can  be  done 
until  this  question  is  answered.  Each  department  must 
know  the  period  for  w^hich  its  estimate  is  to  be  made,  other- 
wise the  various  departmental  estimates  will  in  all  probability 
be  for  different  periods  of  time  and  hence  cannot  be  corre- 
lated. For  instance,  if  the  sales  estimate  is  made  for  six 
months  and  the  production  estimate  for  one  year,  it  is  not 
possible  to  compare  the  two. 

The  length  of  the  budget  period  is  governed  by  a  number 
of  factors,  the  most  important  of  which  are: 

1.  Length  of  merchandise  turnover  period 

2.  Length  of  production  period 

3.  The  method  of  financing  employed 

4.  The  market  conditions 

5.  The  adequacy  and  completeness  of  the  data  with  reference  to 

past  operations 

6.  Length  of  the  accounting  period 


30 


BUDGETARY  CONTROL 


Length  of  Merchandise  Turnover  Period 

If  a  business  has  a  long  turnover  period  and  the  peak  of 
the  sales  comes  at  the  end  of  the  period,  it  is  necessary  for 
the  budget  period  to  be  equal  in  length  to  the  turnover 
period.  Otherwise  it  is  impossible  to  obtain  a  correlation  be- 
tween sales  and  purchases  or  production.  Such  a  condition 
is  apt  to  exist  where  sales  are  affected  by  seasonal  demands. 

To  illustrate,  a  publishing  company  selling  textbooks 
for  use  in  secondary  schools  has  the  principal  volume  of  its 
sales  in  July,  August,  and  September,  just  before  the  open- 
ing of  the  academic  year.  It  has  a  smaller  volume  in  Janu- 
ary prior  to  the  opening  of  the  second  semester,  and  has 
scattering  sales  throughout  the  year.  In  preparing  its  budg- 
ets it  is  preferable  to  make  them  one  year  in  length  but 
subdivided  by  months,  so  that  the  total  required  operations 
of  each  department  for  the  year  can  be  seen  and  these  sched- 
uled by  months.  It  is  necessary  for  the  company  to  have 
some  books  printed  throughout  the  year,  otherwise  it  will 
be  impossible  to  have  sufficient  inventory  on  hand  to  meet 
sales  demands  during  the  rush  season.  Consequently  the 
production  during  any  month  or  quarter  will  not  correspond 
with  the  sales  for  that  month  or  quarter.  During  the 
period  of  slack  sales  the  production  will  exceed  the  sales, 
while  during  the  period  of  large  sales  the  production  will  be 
less  than  the  sales.  It  should  be  easily  seen,  therefore,  that 
it  is  impossible  to  secure  a  coordination  between  the  sales 
estimates  and  the  production  estimates  for  any  period  less 
than  a  year.  Assuming  that  a  uniform  inventory  is  main- 
tained, the  sales  for  the  year  will  equal  the  production  for 
the  year,  but  this  equality  will  not  exist  for  any  shorter 
period  of  time.  Similarly  a  proper  comprehension  of  the 
financial  requirements  of  the  business  can  be  obtained  only 
on  the  basis  of  the  year's  program,  although  estimates  of  cash 
receipts  and  disbursements  can  be  made  monthly. 


PRELIMINARY  STEPS  IN  INSTALLATION 


31 


In  a  business  having  a  long  turnover  period  it  is  usually 
preferable  to  make  the  budget  period  of  corresponding 
length.  On  the  other  hand,  a  business  like  a  grocery  store 
which  has  a  short  turnover  period  will  find  it  feasible  to 
have  a  short  budget  period.  In  such  a  business  sales  are 
apt  to  fluctuate  from  period  to  period,  and  by  having  a  short 
budget  period  it  is  possible  to  take  advantage  of  these  fluc- 
tuations in  making  the  budgetary  program.  If  the  turnover 
period  is  short  it  is  usually  possible  to  purchase  additional 
goods  easily  and  quickly;  therefore  it  is  not  difficult  to  re- 
plenish the  inventory  even  though  sales  are  estimated  for 
only  a  short  period  of  time  in  advance. 

Length  of  Production  Period 

In  a  manufacturing  business  producing  a  commodity 
which  requires  a  long  production  period,  it  may  be  necessary 
to  provide  for  a  budget  period  which  is  at  least  equal  in 
length.  It  is  necessary  to  know  the  sales  a  sufficient  length 
of  time  in  advance  to  make  possible  the  placing  of  orders 
which  wall  result  in  an  inventory  of  sufficient  size  to  meet 
the  sales  demands.  It  is  obvious  that  the  orders  must  be 
placed  a  length  of  time  equal  to  the  production  period  in 
advance  of  the  time  when  the  sales  are  to  be  made.  This  is 
particularly  essential  in  a  business  where  the  sales  fluctuate 
from  period  to  period  and  there  is  a  corresponding  fluctua- 
tion in  the  production.  For  instance,  the  X  Company, 
which  has  a  production  period  of  six  months,  estimates  that 
its  sales  will  increase  50  per  cent  during  the  last  quarter  of 
the  year  1922.  The  production  department  should  be  in- 
formed of  this  expected  increase  by  April  i ,  if  it  is  to  have 
the  inventory  available  to  meet  these  sales.  The  reader  can 
probably  recall  numerous  other  illustrations  which  will  show 
the  relation  between  the  length  of  the  production  period  and 
the  budget  period. 


32 


BUDGETARY  CONTROL 


Method  of  Financing  Employed 

In  some  cases  the  financial  peak  load  comes  at  a  time  of 
the  year  when  it  is  difficult  to  obtain  the  necessary  funds 
quickly.  Consequently,  it  is  desirable  to  make  financial 
arrangements  some  time  in  advance  of  the  period  when  the 
peak  load  will  come.  In  such  cases  it  may  be  necessary  to 
make  the  budget  period  sufficiently  long  to  make  possible 
the  determination  of  financial  requirements  some  months  in 
advance.  If  the  executive  can  go  to  his  banker  several 
months  before  the  funds  are  required  and  show  him  the 
contemplated  plans  of  the  business  with  the  consequent 
demand  for  funds  at  the  time  of  the  peak  load,  he  is  much 
more  apt  to  get  a  promise  of  funds  than  if  he  waits  until  the 
funds  are  urgently  needed.  In  the  latter  case  the  banker 
does  not  see  the  reason  for  the  sudden  demands  for  funds, 
while  in  the  first  case  he  has  seen  months  in  advance  that 
the  plans  of  the  business  would  result  in  a  need  for  funds  at 
that  particular  time. 

The  treasurer  of  a  young  but  rapidly  growing  corpora- 
tion in  New  York  City  has  built  up  a  large  line  of  bank 
credit  for  his  firm  by  following  the  practice  of  taking  his 
financial  budget  to  the  bankers  at  the  beginning  of  each 
year  and  showing  them  the  plans  for  the  year  and  the 
consequent  financial  requirements.  At  the  end  of  the  year 
he  shows  them  a  comparison  between  the  budgets  for  the 
year  and  the  actual  results.  By  this  means  he  shows  them 
his  requirements  and  convinces  them  that  the  credit  which 
he  requests  is  reasonable  and  justified. 

There  is  a  growing  tendency  among  business  finns  to 
determine  their  financial  requirements  for  a  considerable 
period  of  time  in  advance  and  to  arrange  for  the  necessary 
funds  prior  to  the  initiation  of  the  program  which  necessi- 
tates the  funds.  If  provision  for  the  necessary  funds  cannot 
be  made,  the  program  is  revised.    The  advantage  of  this 


PRELIMINARY  STEPS  IN  INSTALLATION 


33 


plan  over  the  far  too  frequent  practice  of  starting  the 
program  and  arranging  for  the  procurement  of  funds  when 
the  necessity  for  them  arises  should  be  apparent  to  the 
reader. 

Market  Conditions 

When  the  market  conditions  are  uncertain  and  variable, 
it  is  desirable  to  make  the  budget  period  as  short  as  possible, 
in  order  that  revisions  in  plans  can  be  made  more  easily. 
Estimates  are  always  difficult  to  make  with  accuracy  and  in 
a  period  of  uncertain  market  conditions  this  difficulty  is 
greatly  increased. 

If  the  sales  estimate  proves  incorrect  this  will  affect  all 
the  other  estimates,  since  most  of  them  are  based,  at  least 
in  part,  on  the  sales  estimate.  For  instance,  it  was  impossi- 
ble for  a  firm  in  January,  1921,  to  estimate  accurately  its 
sales  for  the  year,  and  if  correct  estimates  for  the  year  had 
been  prepared  based  on  the  yearly  sales  estimates,  it  would 
have  been  entirely  a  matter  of  accident.  Many  firms  pre- 
pared their  estimates  for  1 92 1  on  a  quarterly  basis  and  made 
new  estimates  at  the  beginning  of  each  quarter.  Even 
these  they  found  necessary  to  revise  monthly.  For  the 
year  1922  similar  difficulties  exist. 

The  marketing  methods  of  a  business  may  affect  the 
length  of  its  budget  period.  For  instance,  some  of  the  large 
mail-order  houses  issue  catalogues  each  six  months,  which 
quote  prices  effective  for  that  period  of  time.  In  order  to 
protect  themselves  they  find  it  necessary  to  enter  into  con- 
tracts for  the  purchase  of  sufficient  goods  to  satisfy  the 
estimated  sales  demands  for  the  period  covered  by  the  cata- 
logue. As  a  consequence  it  is  necessary  for  these  firms  to 
make  their  budget  period  six  months  in  length,  since  their 
sales  estimates  and  purchase  estimates  must  be  made  for 
this  period  of  time, 
s 


34 


BUDGETARY  CONTROL 


Adequacy  and  Completeness  of  Data 

In  a  new  business,  or  in  an  old-established  one  where 
adequate  records  have  not  been  kept,  it  is  impossible  to 
obtain  adequate  statistics  with  reference  to  past  results. 
Hence  it  is  difficult  to  estimate  future  operations,  for  esti- 
mates should  always  be  made  in  the  light  of  past  events. 
In  such  cases  it  is  better  to  make  the  budget  period  as  short 
as  possible  so  that  new  budgets  can  be  made  as  statistics 
are  obtained  which  will  serve  as  a  basis  for  their  preparation. 

Length  of  Accounting  Period 

After  estimates  are  made,  it  is  necessary  that  means  be 
provided  for  checking  their  accuracy.  This  is  usually 
accomplished  by  preparing  reports  showing  a  comparison 
between  the  estimated  and  the  actual  results.  The  actual 
results  are  obtained  to  a  considerable  extent  from  the 
accounting  records.  The  information  obtained  from  these 
records  is  usually  obtainable  only  at  the  end  of  an  account- 
ing period.  It  is  necessary,  therefore,  that  the  budget  period 
end  on  the  same  day  as  an  accounting  period.  The  budget 
period  may  include  two  or  more  accounting  periods,  so 
long  as  it  commences  on  the  first  day  of  one  period  and 
ends  on  the  last  day  of  the  same  or  some  other  period. 
There  is  a  recent  tendency  of  business  firms  to  secure  the 
information  with  which  to  check  the  budgetary  program 
from  sources  other  than  the  accounting  records.  But  even 
in  this  case,  the  information  so  obtained  is  later  checked 
by  the  accounting  records. 

Usual  Length  of  Budget  Period 

The  usual  length  of  the  budget  period  is  for  three,  six, 
or  twelve  months.  Some  firms  state  their  general  plans  for 
one  year  in  advance  so  as  to  have  a  goal  to  work  for,  but 
work  out  detailed  schedules  for  only  one  month  at  a  time. 


PRELIMINARY  STEPS  IN  INSTALLATION 


35 


A  few  firms  known  to  the  authorrnake  their  budgets  for  one 
year,  and  at  the  end  of  each  month  drop  the  past  month  and 
add  one  month  at  the  other  end  of  the  period.  By  this 
means  they  have  their  budgetary  plans  made  for  twelve 
months  in  advance  at  all  times.  Regardless  of  the  length 
of  time  for  which  the  budgets  are  prepared,  they  must  be 
scheduled  to  show  monthly  expectancies,  so  that  compari- 
sons can  be  made  at  the  end  of  each  month  between  the 
actual  and  the  estimated  performance  and  the  necessary 
revisions  put  into  effect. 

.General  Conclusions  as  to  Length  of  Budget  Period 

It  will  undoubtedly  occur  to  the  reader  of  the  foregoing 
discussion  that  some  of  the  factors,  which  it  is  suggested 
must  be  considered  in  determining  thfe  length  of  the  budget 
period,  afford  an  argument  for  a  short  period  while  others 
afford  an  argument  for  a  long  period.  This  is  undoubtedly 
correct  and  it  is  the  purpose  of  the  discussion  to  emphasize 
this  fact.  It  is  desired  to  suggest  to  the  reader  that  an 
arbitrary  answer  cannot  be  given  to  the  question.  How  long 
shall  the  budget  period  be?  In  each  business  all  the  factors 
suggested  should  be  considered  and  the  length  of  the  budget 
period  determined  as  a  result  of  this  consideration. 

In  conclusion  it  may  be  said  that  it  is  important  that 
two  things  be  accomplished  by  the  budgetary  program : 

1 .  That  the  executives  obtain  a  perspective  of  the  plans  of  the  busi- 

ness for  a  sufficient  length  of  time  in  advance  to  enable  them 
to  adjust  their  plans  to  the  general  program  without  too  much 
abruptness.  This  is  especially  important  in  a  rapidly  grow- 
ing business  or  one  subject  to  material  changes. 

2.  That  the  executives  have  a  definite  and  concrete  program  for  the 

immediate  future  which  they  can  use  as  the  basis  of  day-to-day 
operations.  Such  a  program  is  also  necessary  as  a  basis  for 
comparing  the  actual  with  the  estimated  performance,  and 
unless  this  comparison  is  made  it  is  impossible  to  exercise  an 


36 


BUDGETARY  CONTROL 


effective  control  of  the  budgetary  program.  Such  a  definite 
and  concrete  program  can  usually  be  made  for  only  a  short 
time  in  advance. 

For  these  reasons,  therefore,  it  is  desirable  to  make  at 
least  a  general  program  for  one  year  in  advance  and  to  make 
subsidiary  thereto  a  more  specific  program  for  a  month  or  a 
quarter.  The  latter  program  can  be  used  as  the  basis  for 
immediate  action,  while  the  former  can  be  used  as  the  basis 
for  future  planning.  The  yearly  program  can  be  revised 
monthly  or  quarterly  as  the  changing  conditions  demand. 
In  working  out  some  of  the  programs  of  the  business — ^for 
instance,  the  advertising  program — it  may  be  necessary  to 
make  general  plans  for  two  or  three  years  in  advance. 

Responsibility  for  Preparation  of  Estimates 

At  the  very  inception  of  the  budgetary  program  it  is 
necessary  to  determine  the  responsibility  for  the  preparation 
of  the  various  estimates  which  its  installation  requires.  The 
practice  of  business  firms  in  this  matter  varies  widely.  In 
some  businesses  the  controller  and  his  staff  prepare  the  esti- 
mates and  submit  them  to  the  departmental  executives  for 
revision  or  approval.  This  method  may  secure  satisfactory 
results  if  the  controller  has  a  well-trained  staff  and  if  the 
fluctuations  in  the  volume  of  business  are  small. 

It  is  "the  opinion  of  the  author  that  though  the  controller 
and  his  staff  may  be  able  to  prepare  accurate  estimates,  it 
is  not  desirable  for  this  task  to  be  performed  by  them.  One 
of  the  important  results  of  budgetary  control  is  the  benefit 
derived  by  the  executives  in  its  installation  and  operation. 
If  the  major  part  of  the  work  is  performed  by  a  central 
agency  such  as  the  controller,  those  who  should  benefit  most 
from  the  budgetary  program  lose  the  opportunity  of  gaining 
this  advantage. 

In  most  businesses  the  departmental  executives  are  held 


PRELIMINARY  STEPS  IN  INSTALLATION 


37 


responsible  for  the  preparation  of  the  estimates.  The  sales 
manager  is  held  responsible  for  the  sales  estimate,  the  pro- 
duction manager  is  held  responsible  for  the  production 
estimates,  and  so  on.  Each  departmental  head  will  usually 
delegate  his  responsibility  for  the  preparation  of  the  esti- 
mate of  his  department  to  subordinates.  Practice  varies 
greatly  with  reference  to  the  subordinates  selected  for  this 
task.  If  the  head  of  the  department  has  a  staff,  he  may  ask 
his  staff  assistants  to  perform  the  task.  For  instance,  the 
sales  manager  may  have  the  sales  estimate  prepared  in  his 
office  by  staff  assistants,  and  the  production  manager  may 
do  likewise. 

On  the  other  hand,  the  sales  manager  may  ask  his  branch 
and  division  managers  to  prepare  estimates  of  their  sales, 
and  he  may  then  combine  these  to  get  the  total  estimated 
sales.  In  this  case  the  sales  manager  and  his  assistants  will 
study  the  estimates  submitted  by  the  subordinates  and 
make  revisions  where  necessary.  The  production  manager 
may  ask  his  works  managers  to  submit  estimates,  and  these 
in  turn  may  ask  the  advice  of  their  foremen  or  heads  of  de- 
partments. The  production  manager  and  his  assistants 
will  make  such  revisions  as  the  evidence  they  have  at  hand 
indicates  to  be  necessary. 

Responsibility  for  Performance  Best  Source  of  Estimates 

4t  is  the  experience  of  the  author  that  as  a  general  rule 
better  results  will  be  obtained  if  the  individuals  responsible 
for  the  performance  of  the  estimate  are  the  ones  who  origi- 
nate it.    This  procedure  is  desirable : 

1.  Because  these  individuals  should  be  best  able  to  make  the  esti- 

mate. 

2.  Because  they  will  obtain  the  most  value  from  making  it. 

3.  Because  if  they  are  required  to  make  the  estimate,  they  will  feel 

more  responsible  for  its  enforcement. 


38 


BUDGETARY  CONTROL 


To  illustrate  the  foregoing  by  means  of  the  sales  estimate, 
the  branch  manager  should  know  more  about  the  sales  possi- 
bilities in  his  territory  than  does  the  sales  manager.  If  he 
does  not,  he  ought  to  be  made  to  study  his  territory  until  he 
does.  If  he  is  required  to  make  the  sales  estimate,  either 
he  will  make  it  more  accurately  than  will  the  sales  manager, 
or  the  latter  can  discover  the  incapacity  of  the  branch  man- 
ager and  take  the  necessary  steps  to  correct  the  situation. 
In  making  the  sales  estimate  the  branch  manager  will  learn 
much,  because  its  preparation  will  force  him  to  study  past 
results  and  future  prospects.  Finally,  if  the  branch  mana- 
ger makes  the  original  estimate  he  will  feel  more  responsi- 
bility for  its  enforcement  than  if  it  is  prepared  by  the  general 
office  without  consultation  with  him.  If  he  fails  to  meet  an 
estimate  to  which  he  has  previously  agreed,  he  cannot  object 
to  being  required  to  explain  the  reasons  for  his  failure.  It  is 
of  course  possible  to  enforce  procedures  whether  subordi- 
nates like  them  or  not,  but  this  is  rather  destructive  of 
morale,  and  morale  is  an  important  factor  in  present-day 
administration. 

What  has  been  said  in  the  foregoing  paragraph  with  ref- 
erence to  the  sales  estimate  is  equally  true  w^ith  reference  to 
all  the  other  estimates.  Better  results  will  be  obtained  if 
the  line  subordinates  are  consulted  in  their  preparation. 

Responsibility  for  Reports 

After  the  budgetary  program  is  established,  it  is  neces- 
sary to  have  periodic  reports  showing  the  performance  of 
e^ch  department  so  that  a  comparison  may  be  made  between 
the  estimated  and  the  actual  performance.  To  accomplish 
tl::s  it  is  necessary  that  two  things  be  done: 

1.  That  the  reports  desired  be  determined. 

2.  That  the  responsibility  be  fixed  for  the  preparation  of  these 

reports. 


PRELIMINARY  STEPS  IN  INSTALLATION 


39 


Because  of  the  importance  of  the  reports  used  in  budget- 
ary control,  it  is  desirable  that  considerable  attention  be 
given  to  their  form  and  content.  It  is  preferable  that  they 
be  designed  by  a  central  authority  so  that  the  information 
received  from  all  departments  will  be  in  proper  form  for 
comparison  and  correlation.  The  executive  in  charge  of  the 
budget  procedure  knows  the  form  in  which  the  information 
is  desired  for  his  use  and  for  the  use  of  the  budget  committee, 
hence  he  is  best  able  to  design  the  necessary  reports. 

It  is  advisable  that  the  reports  desired  be  determined  at 
the  beginning  of  the  budget  period  so  that  provision  can  be 
made  for  collecting  the  information  needed  for  their  prepa- 
ration. If  instructions  for  their  preparation  are  not  issued 
until  the  end  of  the  period,  it  is  very  possible  that  some  of 
the  necessary  information  will  not  be  available.  This  not 
only  results  in  a  failure  to  secure  the  desired  information, 
but  also  tends  to  create  ill-will  on  the  part  of  those  who  are 
held  responsible  for  the  preparation  of  the  reports. 

The  departmental  heads  are  responsible  for  the  prepara- 
tion of  the  departmental  estimates,  but  in  many  cases  it  is 
not  possible  to  make  them  responsible  for  the  preparation 
of  the  reports  showing  the  actual  performance.  In  some 
cases  it  is  more  desirable  to  obtain  this  information  from  the 
accounting  department  or  a  central  statistical  department. 

In  any  case,  it  is  necessary  to  determine  from  which  de- 
partment this  information  should  come  and  fix  responsibility 
therefor,  and  this  determination  should  be  reached  very 
early  in  the  course  of  the  budgetary  procedure  in  order 
that  plans  may  be  made  by  the  department  made  respon- 
sible for  the  collection  of  the  required  data. 

Necessity  for  Promptness  in  Preparing  Reports 

In  deciding  the  responsibility  for  the  preparation  of  re- 
ports, careful  attention  should  be  given  to  the  necessity  for 


40 


BUDGETARY  CONTROL 


their  prompt  preparation  after  the  end  of  the  budget  period. 
Unless  they  are  prepared  with  promptness  so  that  the  actual 
and  the  estimated  performance  can  be  compared  imme- 
diately after  the  close  of  the  period,  it  is  impossible  to  make 
the  necessary  revisions  in  the  budgetary  program  which  the 
reports  show  are  necessary.  To  know  the  variations  be- 
tween the  estimated  sales  and  the  actual  sales  of  January  is 
of  value  if  the  knowledge  is  available  on  February  i,  but 
such  knowledge  is  of  little  value  in  controlling  the  budget 
program  for  February  if  not  available  until  February  25. 

It  will  seem  on  first  thought  that  it  is  the  function  of  the 
accounting  department  to  prepare  the  budget  reports. 
There  are  certain  advantages  in  this  procedure  since  it  elimi- 
nates the  possibility  of  duplication  of  work  if  another  depart- 
ment is  required  to  collect  and  report  data  which  will  later 
be  shown  in  the  accounting  records.  The  reports  are  also 
apt  to  be  more  accurate  if  they  are  verified  by  the  formal 
methods  employed  by  the  accounting  department.  It  has 
been  the  author's  expeFie»6e,  however,  that  it  is  difficult  to 
get  the  accounting  department  of  most  businesses  to  sum- 
marize their  records  at  the  end  of  the  period  with  sufficient 
speed  to  make  available  the  desired  reports  at  the  time 
needed.  He  has  found  it  advisable,  therefore,  to  obtain  in- 
formation regarding  actual  performance  from  other  sources 
wherever  possible.  It  is  true  that  the  audited  reports  pre- 
pared from  the  accounting  records  may  differ  slightly  from 
those  prepared  by  the  operating  departments,  but  these 
differences  are  usually  not  of  sufficient  amount  to  affect  the 
conclusions  to  be  drawn  from  the  latter.* 

Method  of  Enforcing  Budgets 

After  the  departmental  estimates  have  been  approved 
it  is  necessary  for  each  department  to  formulate  plans  to 
carry  out  its  estimate.    Unless  this  is  done  the  budgetary 


PRELIMINARY  STEPS  IN  INSTALLATION  41 


program  is  apt  to  result  in  failure.  Many  firms  have  made 
estimates  of  departmental  activities  but  have  failed  to  formu- 
late a  plan  for  their  attainment,  with  the  result  that  the 
actual  has  varied  widely  from  the  estimated  performance 
and  consequently  the  executives  have  tended  to  feel  that 
the  budgets  had  little  or  no  significance.  A  well  thought- 
out  plan  for  the  enforcement  of  the  departmental  estimates 
should  be  formulated  before  the  introduction  of  the  budg- 
etary program. 

The  method  by  which  the  departmental  estimates  will 
be  enforced  wall  vary  with  the  different  departments.  For 
instance,  the  sales  department  may  find  it  necessary  to  set 
up  quotas  for  the  different  sales  units  and  for  salesmen  at 
each  unit  in  order  to  secure  the  amount  of  sales  called  for  by 
its  estimate.  The  production  department  will  find  it  neces- 
sary to  set  up  balance  of  stores  records  so  that  the  inventory 
schedules  called  for  by  the  production  budget  may  be  main- 
tained, and  to  operate  a  planning  department  so  that  its 
schedule  of  finished  goods  may  be  enforced.  Other  depart- 
ments will  find  it  necessary  to  use  similar  means  to  carry  out 
their  programs. 

Some  part  of  this  procedure  may  be  developed  as  the 
budgetary  program  proceeds,  but  it  is  necessary  to  remem- 
ber that  it  is  useless  to  set  up  a  budgetary  program  unless 
means  for  its  enforcement  are  provided,  and  it  is  necessary 
that  the  means  be  developed  as  early  as  possible  in  the 
installation  of  the  budgetary  procedure. 

Cooperation  of  Executives  and  Employees 

In  order  that  the  budgetary  program  be  properly  formu- 
lated and  executed  it  is  necessary  that  all  the  executives 
and  employees  of  the  business  cooperate  to  that  end ;  and  in 
order  to  secure  their  cooperation  it  is  necessary  that  they  be 
instructed  with  reference  to  the  budgetary  plans  so  they 


42 


BUDGETARY  CONTROL 


may  understand  the  relation  of  the  duties  delegated  to  them 
to  the  general  plans  of  the  business.  Although  previous  to 
its  installation  it  is  impossible  to  secure  a  complete  realiza- 
tion by  all  the  executives  and  employees  of  what  the  budget- 
ary program  involves,  as  mach  as  possible  should  be  done 
to  this  end  before  the  budget  program  commences.  If  di- 
plomacy and  tact  are  used  much  can  be  accomplished. 

After  the  budgetary  program  is  installed,  it  is  desirable 
to  have  prepared  a  manual  on  budgetary  procedure  outlining 
the  purpose  of  the  budget  program  and  the  procedure  to  be 
followed  by  all  departments  and  units  of  the  business  in  its 
preparation.  If  this  manual  is  placed  in  the  hands  of  all 
those  responsible  for  the  performance  of  duties  in  connection 
with  the  budget  program,  it  will  aid  them  to  see  the  necessity 
and  desirability  for  prompt  and  efficient  cooperation  on 
their  part.  The  contents  of  such  a  manual  is  discussed  and 
illustrated  in  Chapter  XXIII. 

Much  more  might  be  said  with,  reference  to  the  impor- 
tance of  securing  the  cooperation  of  executives  and  em- 
ployees, but  it  is  thought  that  the  necessity  for  this  coopera- 
tion is  evident. ,  The  method  which  should  be  employed  to 
secure  their  cooperation  will  depend  on  the  circumstances 
of  each  case.  Tact,  courtesy,  and  patience  are  all  neces- 
sary, and  these  should  be  backed  up  by  determination  based 
on  confidence  in  the  program  and  comprehensive  knowledge 
of  the  method  of  executing  it. 


CHAPTER  IV 


ORGANIZATION  FOR  BUDGETARY  CONTROL 

Need  for  Organization 

The  preceding  chapters  have  shown  that  in  the  operation 
of  budgetary  control  it  is  necessary  to  formulate  a  com- 
prehensive procedure  which  will  govern  the  preparation, 
correlation,  and  enforcement  of  the  departmental  estimates. 
To  insure  the  carrying  out  of  the  budgetary  procedure, 
it  is  necessary  to  set  up  an  organization  responsible  for 
its  enforcement;  and  it  is  desirable  that  this  organiza- 
tion be  effected  before  the  budgetary  program  is  initiated, 
for  otherwise  there  will  be  no  fixed  responsibility  for  its 
enforcement,  and  delays  and  errors  are  almost  sure  to  occur. 
These  errors  and  delays  tend  to  lessen  the  interest  and  en- 
thusiasm of  the  executives  and  employees  in  the  budgetary 
program,  and  this  in  turn  renders  its  successful  completion 
more  difficult.  It  is  the  purpose  of  this  chapter  to  indicate 
the  nature  of  the  organization  which  many  business  firms 
have  found  desirable. 

Head  of  the  Budgetary  Program 

Previous  chapters  have  emphasized  the  interrelation  of 
the  activities  of  the  functional  departments  and  the  need 
of  a  correlation  of  these  activities.  Since  it  is  the  purpose  of 
budgetary  control  to  effect  this  correlation,  the  budgetary 
program  is  as  broad  and  comprehensive  as  the  business 
itself.  Inasmuch  as  the  budgetary  program  involves  the 
activities  of  all  the  departments,  it  is  not  expedient  to  dele- 
gate its  execution  to  any  one  department.  Rather,  it  is 
necessary  to  set  up  an  organization  which,  although  it  must 

43 


44 


BUDGETARY  CONTROL 


include  the  executives  of  all  departments,  has  a  central 
head  which  is  independent  and  superior  to  the  departmental 
executives. 

In  harmony  with  this  conclusion,  it  is  desirable  that  the 
president  or  chief  executive  of  the  business  should  have 
direct  control  of  all  matters  pertaining  to  the  budgetary 
program.  He  must  of  necessity  delegate  most  of  the  duties 
imposed  on  him  by  this  program  to  subordinate  officers,  but 
these  officers  should  act  as  his  agents  and  be  directly  re- 
sponsible to  him  for  the  proper  performance  of  the  duties 
delegated  to  them.  In  case  of  disagreement  between  de- 
partments with  reference  to  the  coordination  of  estimates, 
the  decision  of  the  president  must  be  final. 

Disadvantages  of  Not  Having  Chief  Executive  at  Head 

The  importance  of  having  the  chief  executive  in  direct 
and  immediate  control  of  the  budgetary  program  cannot  be 
overemphasized,  for  unless  this  be  done  two  undesirable 
situations  may  develop : 

1.  The  departmental  executives  and  their  subordinates 
will  fail  to  realize  the  importance  of  the  budgetary  work  and 
will  not  give  it  the  time  and  attention  necessary  to  make  it 
worth  while.  If  they  are  required  to  submit  estimates  and 
to  make  reports  regarding  their  execution  to  some  subordi- 
nate official,  or  even  to  the  head  of  some  other  functional 
department,  such  as  the  general  auditor's,  they  are  apt  to 
resent  what  they  will  regard  as  an  undue  interference  with 
their  activities  by  one  who  is  not  directly  concerned  with 
them. 

2.  Disagreements  will  arise  with  reference  to  the  co- 
ordination of  departmental  programs.  For  instance,  the 
sales  department  may  desire  to  sell  more  than  the  produc- 
tion department  thinks  it  can  produce  profitably,  or  the 
production  department  may  desire  to  produce  articles  which 


ORGANIZATION  FOR  BUDGETARY  CONTROL  45 

the  sales  department  does  not  think  it  can  sell,  or  both  the 
sales  and  production  departments  may  desire  to  increase 
their  activities  beyond  what  the  financial  department  thinks 
can  be  financed.  Obviously  the  only  authority  who  can 
decide  these  questions  is  the  chief  executive  who  is  superior 
to  all  the  executives  interested  in  the  controversy.  These 
departmental  executives  will  not  accept  as  final  the  decision 
of  an  officer  of  equal  or  lower  rank  to  themselves.  Further- 
more, if  the  executives  in  charge  of  the  preliminary  work  on 
the  budget  are  the  direct  representatives  of  the  chief  execu- 
tive they  are  apt  to  be  given  more  consideration  than  if  they 
are  members  of  a  subordinate  department. 

Direct  Control  of  Governmental  Budgets  by  Chief  Executive 

Inthepreparation  of  governmental  budgetsit  hasusually 
been  assumed  that  final  control  and  responsibility  is  vested 
in  the  chief  executive.  Consequently  he  is  usually  required 
to  submit  to  the  legislative  body  the  proposed  budget  with 
his  personal  approval,  and  he  is  held  directly  accountable 
for  its  contents.  In  the  enactment  of  the  recent  legislation 
creating  budgetary  control  for  the  United  States  govern- 
ment, there  was  much  discussion  with  reference  to  the  rela- 
tion of  the  President  to  the  budgetary  organization.  The 
Senate  desired  to  place  the  Budget  Bureau  in  the  Treasury 
Department,  while  the  House  desired  to  make  it  independ- 
ent of  any  department  and  answerable  directly  to  the 
President.  The  New  York  Evening  Post  discussing  the 
proposed  law  very  ably  sets  forth  the  arguments  for  placing 
the  President  in  direct  control  of  the  Budget  Bureau,  in  the 
following  editorial  entitled  "The  Right  Kind  of  Budget": 

Passage  by  the  Senate  of  the  McCormick  budget  bill  is  gratify- 
ing as  a  forecast  of  the  early  establishment  of  a  budget  system  at 
Washington.  But  it  is  highly  desirable  that  we  get  the  right  kind  of 
budget  system.    Otherwise  the  work  will  have  to  be  done  over. 


46 


BUDGETARY  CONTROL 


One  of  the  prime  essentials  of  a  proper  budget  isthat  it  be  placed 
directly  under  the  President,  The  McCormickbill  places  the  system 
in  the  Treasury  Department.  On  the  other  hand,  the  Good  bill, 
which  has  been  introduced  in  the  House,  places  the  Budget  Bureau 
directly  under  the  President.  This  undoubtedly  is  the  course  that 
should  be  followed.  The  McCormick  arrangement,  if  not  fatal  to 
the  right  function  of  a  budget  system,  would  greatly  hamper  it.  The 
reasons  lie  on  the  surface.  One  of  the  most  important  duties  of  the 
chief  budget  officer  will  be  to  cut  the  estimates  submitted  to  him  by 
Cabinet  officers.  It  takes  no  great  stretch  of  the  imagination  to  see 
the  situation  that  will  be  created  if  an  official  connected  with  a  par- 
ticular department  cuts  the  estimates  that  come  from  other  depart- 
ments. Think  of  a  budget  official  passing  upon  the  estimates  of  his 
chief.  Inevitably  there  will  be  a  feeling  that  the  department  to 
which  the  budget  system  is  attached  is  being  favored.  In  order  that 
the  system  may  have  a  fair  chance,  it  must  be  in  exactly  the  same 
relation  to  all  the  departments.  With  respect  to  it,  just  as  with  re- 
spect to  the  President  and  Congress,  the  departments  must  be  on 
the  same  plane.  A  budget  officer  representing  the  President  will  be 
in  a  very  different  position  from  a  budget  officer  representing  the 
Treasury. 

The  argument  is  no  less  strong  with  reference  to  the  relation  be- 
tween the  budget  and  the  President.  No  matter  where  the  budget 
system  is  placed,  the  President  will  be  the  final  arbiter  in  important 
differences  between  the  budget  officer  and  the  department  heads.  It 
will  be  much  easier  for  him  to  settle  these  differences  if  the  budget  is 
part  of  his  office  than  if  it  is  connected  with  one  of  the  departments. 
In  the  latter  case  appeal  would  first  be  taken  from  the  budget  officer 
to  the  head  of  the  department  and  then  to  the  President.  This 
would  put  the  President  in  the  delicate  position  of  having  to  decide 
between  two  of  his  Cabinet  officers.  With  the  budget  officer  a  part 
of  the  President's  Staff,  the  final  conference  would  consist  of  the 
President,  the  budget  officer,  the  department  head  and  perhaps  the 
head  of  the  bureau  affected — a  much  more  promising  assemblage 
for  an  objective  consideration  of  the  case. 

The  budget  officer  will  not  be  a  mere  reducer  of  figures.  To  be 
of  the  greatest  usefulness,  he  will  make  it  his  business  to  keep  the 
President  informed  of  the  activities  of  the  various  departments.  He 
will  follow  up  his  work  on  the  estimates  each  year  by  observing  the 
way  in  which  the  appropriations  are  spent,  continually  reporting  to 


ORGANIZATION  FOR  BUDGETARY  CONTROL 


47 


the  President.  This  valuable  service,  it  is  obvious,  can  be  rendered 
much  better  by  an  officer  attached  to  the  President's  Staff,  than  by 
one  attached  to  a  department.  Under  the  latter  arrangement,  in- 
deed, it  would  be  rendered  at  a  maximum  of  difficulty. 

As  is  well  known,  the  Senate  and  the  House  compro- 
mised their  differences  by  placing  the  Budget  Bureau  nomi- 
nally in  the  Treasury  Department,  but  with  the  Director 
of  .the  Bureau  reporting  directly  to  the  President.  Since 
the  appointment  of  the  present  Director,  the  President  has 
taken  care  to  emphasize  to  the  departmental  heads  that  the 
Director  is  the  representative  of  the  President  and  that  his 
requests  should  be  treated  as  if  the  President  himself  made 
them. 

The  arguments  set  forth  in  the  foregoing  quotation  apply 
with  slight  modification  to  the  organization  for  budgetary 
control  of  the  private  enterprise.  The  chief  executive  must 
be  both  the  nominal  and  active  head  of  the  budgetary  organ- 
ization. 

The  Budget  Committee 

In  all  businesses  where  a  functional  organization  exists 
the  budgetary  program  will  usually  be  expedited  and  bene- 
fited by  the  establishment  of  a  budget  committee.  This 
committee  will  consist  of  the  principal  functional  executives, 
with  the  president  as  chairman.  In  a  manufacturing  busi- 
ness it  will  usually  be  satisfactory  to  have  it  composed  of  the 
president,  the  sales  manager,  production  manager,  treasurer, 
personnel  manager,  and  controller  or  general  auditor.  In  a 
merchandise  business  the  president,  merchandise  manager, 
treasurer,  personnel  manager,  and  controller  may  be  suffi- 
cient. 

Under  the  authority  and  direction  of  the  president  the 
budget  committee  considers  all  departmental  estimates  and 
makes  changes  and  revisions  as  it  may  think  desirable.  No 


48 


BUDGETARY  CONTROL 


estimate  is  to  be  effective  until  it  has  received  the  approval 
of  the  budget  committee.  In  case  the  budget  committee 
cannot  agree  with  reference  to  any  estimate,  the  question  in 
dispute  is  left  to  the  president  and  his  decision  is  final.  In 
case  the  judgment  of  the  president  does  not  agree  with  that 
of  the  majority  of  the  committee,  he  has  the  privilege  of 
overruling  them  since  he  is  the  head  of  the  budgetary  organi- 
zation. A  wise  executive  would  take  such  a  step,  however, 
only  in  extreme  cases,  for  the  success  of  the  budgetary  pro- 
gram depends  to  a  considerable  degree  upon  the  cooperation 
of  the  executives. 

In  the  consideration  of  the  departmental  estimates  the 
budget  committee  may  call  on  departmental  heads  to  ex- 
plain reasons  for  the  variations  in  their  estimates  from  the 
estimates  for  past  periods,  or  to  explain  why  changes  cannot 
be  made  which  the  committee  thinks  desirable.  By  this 
means  the  committee  obtains  full  information  on  the  sub- 
ject before  making  its  decisions.  When  the  departmental 
estimates  have  been  approved  by  the  committee  and  the 
president,  they  then  become  the  working  budgets  for  the 
departments.  Of  course  they  may  have  to  be  submitted  to 
the  board  of  directors  for  approval  before  becoming  effective. 

At  the  end  of  stated  periods  of  time,  preferably  monthly, 
the  committee  will  receive  reports  showing  a  comparison  of 
the  performance  for  the  period  with  the  estimated  perform- 
ance. For  instance,  it  will  receive  a  comparison  of  the  sales 
for  the  month  with  the  estimated  sales  for  the  month ;  of  the 
actual  production  with  the  estimated  production ;  and  of  the 
actual  expenses  of  each  department  with  the  estimated  ex- 
penses. On  the  basis  of  these  reports  it  may  make  revisions 
in  the  budgets  for  the  remainder  of  the  budget  period 
if  it  deems  such  revisions  necessary.  The  receiving  of  such 
reports  and  the  making  of  such  revisions  are  a  very  impor- 
tant part  of  the  committee's  duties. 


ORGANIZATION  FOR  BUDGETARY  CONTROL 


49 


It  is  of  little  value  to  make  budgets  unless  a  check  is 
maintained  on  those  who  are  responsible  for  their  execution, 
and  unless  such  a  check  is  maintained,  proper  attention  will 
not  be  given  to  the  preparation  or  the  execution  of  the 
budgets.  Furthermore,  budgets  deal  with  future  operations 
and  are  therefore  apt  to  be  inaccurate.  It  is  essential  that 
these  inaccuracies  be  discovered  and  corrected  as  quickly  as 
possible.  It  is  exceedingly  unwise  to  make  plans  covering 
any  considerable  period  of  time  and  to  follow  these  plans 
blindly  without  taking  into  consideration  the  changing  con- 
ditions which  could  not  be  foreseen  when  the  plans  were 
made. 

Executive  in  Charge  of  Budgetary  Procedure 

If  the  departmental  estimates  and  the  periodic  reportsare 
to  reach  the  budget  committee  at  the  proper  time  for  their 
consideration,  a  definite  procedure  must  be  established  for 
their  preparation  and  submission ;  and  after  this  procedure 
is  established,  there  must  be  an  executive  responsible  for  its 
execution.  Although  the  president  is  the  head  of  the  budg- 
etary program,  he  cannot  assume  responsibility  for  the  direct 
supervision  of  the  budgetary  procedure  and  therefore  must 
delegate  this  duty  to  some  other  executive.  In  a  business 
where  there  exists  a  controller  he  may  very  well  be  charged 
with  the  direct  supervision  of  the  budgetary  procedure. 

In  many  businesses  there  is  no  controller,  and  in  many 
where  there  is  an  executive  known  by  that  title  he  in  fact 
acts  only  as  head  of  the  accounting  department  and  is  not  a 
controller  in  the  correct  sense  of  the  word.  In  those  busi- 
nesses where  there  is  no  controller  the  supervision  of  the 
budgetary  procedure  may  well  be  delegated  to  a  member  of 
the  staff  of  the  president.  This  executive  may  be  given  a 
distinctive  title  or  he  may  merely  be  termed  "staff  assist- 
ant to  the  president."    Since  the  businesses  which  have  a 

4 


50 


BUDGETARY  CONTROL 


controller  are  by  far  in  the  minority,  it  will  be  assumed  in 
the  remainder  of  this  discussion  that  a  staff  assistant  of  the 
president  is  the  executive  in  charge  of  the  budgetary  pro- 
cedure. 

Duties  of  Executive  in  Charge  of  Budgetary  Procedure 

Under  the  authority  and  direction  of  the  president,  the 
staff  assistant  to  the  president  has  general  control  and  su- 
pervision over  the  preparation  and  execution  of  the  budg- 
etary program.  His  general  duties  are  indicated  by  the 
following  summarized  outline: 

1.  To  receive  from  the  departmental  heads  the  periodic  estimates 

which  will  be  discussed  and  illustrated  in  the  following  chap- 
ters. In  order  that  these  estimates  may  be  made  in  the  proper 
form  for  his  use,  he  may  design  forms  for  the  use  of  the  de- 
partments in  the  submission  of  their  estimates. 

2.  To  transmit  these  estimates  to  the  budget  committee  with  such 

recommendations  as  he  may  think  necessary.  He  may  com- 
bine and  summarize  these  estimates  so  that  they  may  be  sub- 
mitted to  the  budget  committee  in  the  form  which  will  make 
them  most  useful  to  it.  It  is  usually  his  function  to  prepare 
from  the  departmental  estimates  an  estimated  balance  sheet 
and  an  estimated  statement  of  profit  and  loss  for  submission 
to  the  budget  committee  and  the  board  of  directors.  These 
show  the  estimated  effect  of  the  contemplated  program  on  the 
financial  condition  and  earnings  of  the  company. 

3.  To  supply  the  budget  committee  with  all  the  information  avail- 

able which  will  assist  it  in  the  consideration  of  the  estimates. 
He  should  have  assistants  whom  he  should  use  in  the  collecting 
of  statistical  data  and  the  translating  of  these  data  into  the 
form  of  reports  and  charts  which  will  be  useful  to  both  the 
budget  committee  and  the  department  heads. 

4.  To  receive  from  the  budget  committee  the  estimates  as  approved  - 

and  transmit  these  to  the  departmental  heads. 

5.  To  receive  periodic  reports  prepared  by  the  operating  depart- 

ments or  the  accounting  department  showing  the  performance 
of  each  department  during  the  budget  period. 


ORGANIZATION  FOR  BUDGETARY  CONTROL  5 1 


6.  To  transmit  periodic  reports  to  the  budget  committee  showing  a 

comparison  between  the  estimated  performance  and  the  actual 
performance  for  the  period  for  each  department,  and  to  make 
any  recommendations  with  reference  to  revisions  which  he 
thinks  necessary. 

7.  To  transmit  to  the  departmental  heads  any  revisions  in  the 

original  estimates  which  have  been  made  by  the  budget  com- 
mittee. 

8.  To  recommend  to  the  president  and  to  the  budget  committee  any 

changes  in  the  budget  procedure  which  he  may  think  necessary ; 
and  to  enable  him  to  make  these  recommendations,  he  should 
be  continually  making  studies  and  doing  research. 

The  staff  assistant  usually  acts  as  secretary  to  the  budget 
committee,  and  in  this  capacity  is  constantly  available  for 
consultation  with  the  members  of  the  committee.  He  has 
the  implied  authority  to  do  everything  necessary  to  the 
proper  performance  of  the  duties  expressly  stipulated  for 
him. 

Importance  of  Staff  Assistant's  Work 

It  is  important  that  the  staff  assistant  in  charge  of  the 
budgetary  procedure  should  not  be  regarded  as  doing  work 
of  a  clerical  nature.  His  function  is  something  more  than 
the  supervision  of  the  budgetary  routine.  In  the  operations 
of  the  budgetary  program  many  questions  of  policy  will 
arise.  The  departmental  executives  will  often  differ  with 
reference  to  these  questions.  It  is  the  duty  of  the  staff 
assistant  to  study  these  and  be  able  to  offer  to  the  budget 
committee  and  the  president  the  matured  judgment  of  an 
impartial  observer.  His  work  brings  him  in  touch  with  all 
the  departments  of  the  business  and  should  enable  him  to 
have  a  more  comprehensive  view  of  it  than  is  usually  pos- 
sessed by  the  line  executives.  As  a  result  he  should  be  able  to 
make  recommendations  and  suggestions  as  to  new  methods 
and  policies  which  will  be  beneficial  to  the  business.  He 


52 


BUDGETARY  CONTROL 


should  also  make  a  practice  of  collecting  data  which  will 
serve  as  a  basis  of  more  accurate  estimates.  By  these  means 
he  can  become  one  of  the  most  important  executives  in  the 
organization. 

Departmental  Executives 

The  executive  heads  of  the  functional  departments  are 
responsible  for  the  preparation  of  the  estimates  of  their 
departments  at  the  time  and  in  the  manner  prescribed  by 
the  adopted  procedure.  They  are  also  responsible  in  some 
cases  for  the  periodic  reports  showing  the  performance  for 
the  period.  Some  of  the  periodic  reports  are  obtained  from 
the  accounting  department,  while  some  are  obtained  from 
the  operating  departments.  Usually  the  operating  depart- 
ments will  submit  reports  more  quickly  than  the  accounting 
department,  and  promptness  is  necessary  in  order  to  use  the 
reports  effectively.  Any  recommendations  which  a  depart- 
mental executive  desires  to  make  with  reference  to  changes 
in  budgetary  procedure  will  be  transmitted  in  writing  to  the 
staff  assistant  to  the  president,  who  in  turn  will  transmit  it 
to  the  budget  committee  for  consideration. 

There  is  a  difference  of  opinion  among  executives  with 
reference  to  the  extent  to  which  the  departmental  head 
should  delegate  the  duty  of  preparing  the  estimates  of  his 
department.  As  explained  in  Chapter  III,  it  is  the  opinion 
of  the  author  that  the  preparation  of  the  original  estimate 
should  be  delegated  as  far  as  possible  to  the  one  who  will  be 
responsible  for  the  carrying  out  of  the  estimate  after  it  has 
been  adopted. 

Board  of  Directors 

In  many  businesses  the  budgetary  program  after  it  has 
been  formulated  and  approved  is  submitted  to  the  board 
of  directors.    In  case  the  program  involves  a  radical  change 


ORGANIZATION  FOR  BUDGETARY  CONTROL 


53 


in  policy  or  the  acquirement  of  a  large  amount  of  capital, 
they  may  deem  it  necessary  to  modify  it.  The  staff  assist- 
ant to  the  president  should  have  available  data  which  will 
serve  to  show  the  modifications  which  are  possible  and  their 
effect  on  the  program  as  a  whole. 

If  modifications  are  necessary,  the  board  of  directors 
may  instruct  the  chief  executive  to  prepare  a  budget  giving 
effect  to  the  changes  which  they  desire.  In  this  case  all  the 
departments  may  be  required  to  submit  new  estimates,  or 
the  changes  may  be  such  that  they  can  be  made  by  the 
budget  committee.  In  any  case  the  changes  as  made  must  be 
transmitted  to  the  departmental  heads  by  the  staff  assistant 
to  the  president. 

Although  it  is  well  and  proper  to  have  the  budgets  sub- 
mitted to  the  board  of  directors  for  consideration  and 
approval,  they  should  be  transmitted  to  it  only  after  they 
have  been  put  into  completed  form.  It  is  obvious  that  the 
directors  are  not  interested  in  the  details  of  preparation, 
and  therefore  the  budget  committee  should  have  completed 
its  work  before  the  budgets  are  sent  to  the  directors.  Un- 
doubtedly the  tendency  for  the  board  of  directors  to  give 
consideration  to  the  budgetary  program  will  be  increased 
in  the  years  to  come. 


CHAPTER  V 


THE  SALES  BUDGET 

Importance  of  Sales  Information 

In  the  preceding  chapters  the  fact  has  been  emphasized 
that  all  of  the  functional  departments  of  a  business  are 
closely  related  and  that  the  activities  of  each  department 
are  dependent  to  a  considerable  extent  upon  the  activities  of 
all  the  other  departments.  In  fact  it  is  because  of  this  inter- 
relation and  interdependence  of  departmental  activities 
>that  budgetary  control  is  necessary.  It  is  difficult  to  con- 
sider the  activities  of  any  one  department  without  consider- 
ing to  some  extent  their  effect  on  the  activities  of  all  the 
other  departments,  and  vice  versa.  In  the  formulation  of 
the  plans  of  any  one  department  for  the  ensuing  budget 
period,  it  is  necessary  to  consider  at  every  stage  of  their 
development  their  effect  upon  the  plans  of  every  other  de- 
partment. Modifications  and  revisions  are  often  necessary 
in  order  to  effect  coordination. 

It  will  be  necessary  in  the  present  chapter  and  in  those 
which  are  to  follow  to  discuss  the  functional  departments 
separately,  but  it  is  deemed  wise  to  emphasize  again  the 
interdependence  of  the  activities  of  these  departments,  so 
that  the  reader  will  keep  this  characteristic  of  business 
organization  constantly  in  mind. 

The  initial  step  in  the  budgetary  program  is  usually 
made  by  the  sales  department.  The  reason  for  this  is  easily 
seen.  The  object  of  the  operations  of  a  business  is  to  make 
a  profit,  and  sales  conclude  the  process  which  results  in  the 
making  of  a  profit.  Until  the  sales  take  place,  consequently 
no  profit  is  realized.    Whenever  the  sales  are  profitable,  the 

54 


THE  SALES  BUDGET 


55 


executives  of  a  business  desire  to  increase  their  sales,  and 
they  try  to  coordinate  all  the  activities  of  the  business  to 
accomplish  this  end.  It  follows  that  the  activities  of  the 
sales  department  exercise  a  very  important  influence  over 
the  activities  of  all  the  other  departments.  This  influence 
is  of  primary  importance  in  both  a  mercantile  and  a  manu- 
facturing business. 

It  is  customary,  therefore,  for  the  sales  department  to 
prepare  a  sales  estimate  which  sets  forth  the  sales  which  are 
desired  and  deemed  possible  during  the  next  budget  period. 
This  estimate  must  then  be  studied  in  comparison  with  the 
future  possibilities  of  the  other  departments  as  set  forth  in 
their  estimates,  in  order  to  arrive  at  a  properly  coordinated 
budget  for  the  entire  business.  The  revised  sales  estimate 
or  the  "sales  budget"  then  becomes  the  working  program  of 
the  sales  department. 

Need  and  Importance  of  the  Sales  Estimate 

The  owners  or  officers  of  either  a  trading  or  a  manufac- 
turing industry  of  necessitymust  estimate  the  probable  sales 
of  their  business  for  each  season  or  fiscal  period.  These 
estimates  may  be  made  very  unscientifically  and  be  recorded 
quite  informally,  or  they  may  be  made  as  the  result  of  a  very 
careful  analysis  of  all  the  factors  involved  and  presented  by 
means  of  a  formal  report.  But,  in  any  case,  an  estimate 
of  sales  must  be  prepared  as  a  basis  of  planning  for  the 
future. 

In  a  trading  business,  the  nature  and  amount  of  goods 
to  be  purchased  depends  upon  the  plans  of  the  sales  depart- 
ment. In  a  manufacturing  business,  the  volume  and  nature 
of  production  is  dependent  on  the  sales  estimated.  If  a 
sales  estimate  is  not  made  by  the  sales  department,  the 
probable  sales  must  be  estimated  by  the  purchasing  depart- 
ment or  the  production  department;  otherwise  these  de- 


56 


BUDGETARY  CONTROL 


partments  have  no  basis  for  their  plans.  It  is  the  purpose 
of  the  present  discussion  to  emphasize  the  point  that  it  is 
properly  the  function  of  the  sales  department  to  prepare 
this  estimate,  and  to  explain  the  method  by  which  it  is  pre- 
pared. 

It  is  evident  that  in  a  mercantile  store  goods  must  be 
bought  and  placed  on  the  shelves  or  in  the  warerooms  before 
they  can  be  sold.  It  will  later  be  explained  how  in  a  manu- 
facturing business  goods  may  sometimes  be  sold  before  they 
are  produced,  but  such  is  not  the  case  in  the  typical  mercan- 
tile business.  Consequently,  in  this  type  of  business,  before 
the  buyers  can  make  contracts  and  select  the  qualities  and 
kinds  of  goods  that  are  to  be  offered  for  sale,  the  manage- 
ment must  make  estimates,  however  scientific  or  unscien- 
tific, as  to  the  volume  and  character  of  sales  expected  for 
any  given  period. 

The  small  retailer  whose  business  is  restricted  to  one 
particular  specialized  commodity,  say  a  dealer  in  rare 
oriental  rugs,  may  say  that  he  will  buy  what  he  can  and 
plan  for  the  sale  of  the  merchandise  after  he  has  it  in  his  pos- 
session. But  a  large  retail  business,  such  as  a  department 
store,  that  sells  many  thousands  of  different  items  of  mer- 
chandise, must  set  up  a  program  of  what  sales  are  expected 
to  be,  if  purchases  are  to  be  made  intelligently  in  source 
markets  all  over  the  world  and  deliveries  to  the  shelves  of 
the  store  completed  before  the  customers  of  the  store  come 
to  buy.  Even  in  the  case  of  the  dealer  of  oriental  rugs  it  is 
probable  that  he  will  learn  by  experience  that  certain  kinds 
or  types  of  rugs  sell  more  readily  than  others.  When  he 
makes  his  purchases,  he  will  be  guided  by  that  experience 
and  will  seek  the  popular  kinds  of  rugs  for  his  antici- 
pated sales.  In  so  far  as  he  does  this,  he  is  estimating  his 
future  sales.  In  other  words,  he  is  making  an  infomial 
sales  estimate. 


THE  SALES  BUDGET 


57 


Anticipated  Sales  the  Basis  for  Action  for  All  Departments 

Not  only  does  the  volume  and  nature  of  the  sales  antici- 
pated, as  reflected  in  the  sales  estimate,  affect  the  buyers  in 
their  selection  of  goods,  but  it  also  vitally  affects  the  opera- 
tions and  plans  of  the  various  functional  managers  of  the 
business.  The  officers  of  the  store  who  are  responsible  for 
providing  proper  space  for  counter  stocks,  for  reserve 
stocks,  and  for  wareroom  stocks,  must  have  before  them 
some  tangible  data  as  to  when  such  stocks  will  be  purchased, 
when  sold,  and  what  volume  of  sales  will  be  made.  In  de- 
partment stores  and  mail-order  houses,  where  large  stocks 
are  carried,  this  is  especially  important. 

The  operating  managers  above  mentioned  must  work 
with  an  estimate  of  sales  in  mind,  so  that  they  may  secure 
the  proper  sales  persons  and  then  train  them  to  meet  the 
needs  of  the  organization.  Similarly  the  operating  officials 
must  anticipate  the  volume  and  character  of  sales  to  a  fairly 
accurate  degree,  if  they  are  to  employ  an  economical  num- 
ber of  packers,  wrappers,  telephone  operators,  delivery  men, 
and  the  like,  and  if  they  are  to  train  these  employees  into  an 
efficient  working  force  animated  with  the  service  ideals  of 
the  store,  and  thoroughly  familiar  with  the  operations,  proc- 
esses, procedures,  and  schedules  in  retail  selling  and  order 
buying. 

The  treasurer  or  other  officer  charged  with  the  responsi- 
bility of  financing  the  purchases  and  expenses  of  the  store 
must  have  very  definitely  in  mind  the  volume  of  revenue 
from  sales  that  the  store  may  reasonably  expect  to  receive 
from  week  to  week,  and  even  from  day  to  day.  The  owners 
themselves,  or  the  president  or  general  manager  as  their 
agent,  must  carefully  study  expected  sales  in  investing 
capital  in  new  divisions  or  departments  of  the  store,  in 
making  additions  or  extensions  of  physical  plant,  or  in  mak- 
ing decisions  concerning  new  forms  of  customers'  credits. 


BUDGETARY  CONTROL 


Place  of  Sales  Estimate  in  a  Wholesale  or  Retail  Store 

In  short,  the  owners  and  officers  of  a  wholesale  or  retail 
store  of  appreciable  size  must  set  up  a  sales  program  for 
each  season  or  fiscal  period  in  order  that  the  customer  may 
receive  service  resulting  from  coordinated  purchasing,  oper- 
ating, financing,  and  plant  maintenance  and  extension. 
For  instance,  in  a  department  store,  if  the  various  depart- 
mental buyers  who  are  purchasing  goods  in  different 
markets  are  to  work  as  a  unit,  they  must  know  not  only 
what  volume  of  sales  in  their  own  particular  lines  they  are 
anticipating  by  their  contracts,  but  they  must  also  know 
something  of  the  character  and  volume  of  sales  expected  in 
all  the  other  lines  of  the  store,  so  that  they  may  select  and 
purchase  qualities  and  quantities  complementary  and  sup- 
plementary to  the  other  lines  of  goods  handled  by  the  store. 

But  the  departmental  buyers  must  not  only  work  in 
harmony  with  each  other;  they  must  work  in  harmony  with 
the  traffic  manager,  the  superintendent  of  warehouses,  and 
the  superintendent  of  delivery  service.  The  one  vital  point 
of  contact  between  the  selector  of  merchandise  and  the 
operating  man  who  handles  the  order  for  the  customer,  is 
that  they  both  promise  their  work  on  the  same  expectancy 
or  estimate  as  to  volume  and  character  of  business.  It  can 
be  readily  seen,  therefore,  that  comprehensive  and  accurate 
information  with  reference  to  sales  anticipated  is  of  utmost 
importance  in  the  internal  control  and  management  of  a 
modern  wholesale  or  retail  store. 

The  Sales  Estimate  in  a  Manufacturing  Business 

In  a  manufacturing  business  the  sales  estimate  is  as 
necessary  for  coordination  of  departmental  activities  as  in 
the  case  of  a  mercantile  establishment.  The  production 
manager  must  base  his  production  program  on  the  antici- 
pated sales ;  otherwise  excess  stocks  will  accumulate  or  orders 


THE  SALES  BUDGET 


59 


will  go  unfilled.  The  plant  engineer  must  plan  his  building 
and  equipment  program  to  meet  the  production  program 
demanded  by  the  sales  estimate.  The  employment  or  per- 
sonnel department  must  consider  the  increased  or  decreased 
demand  for  employees  which  will  result  from  the  program  of 
the  next  budget  period.  The  purchasing  agent  must  make 
contracts  for  raw  materials  and  supplies  and  schedule  de- 
liveries in  order  to  meet  the  demands  of  the  production 
budget.  The  shipping  department  must  adjust  its  capacity 
to  meet  the  demands  of  the  sales  program.  The  treasurer 
must  know  the  estimated  revenue  from  sales  as  well  as  the 
probable  disbursements  arising  from  the  financing  of  the 
sales  program  and  the  consequent  production  program,  in 
order  to  provide  for  the  necessary  funds.  Thus  each  de- 
partment of  the  business  is  affected  by  the  volume  of  busi- 
ness and  the  volume  of  business  is  determined  by  the  amount 
of  the  sales.  Consequently  a  knowledge  of  the  amount  of 
the  sales  anticipated  is  necessary  in  order  to  plan  the  opera- 
tions of  the  business  in  such  a  manner  as  to  secure  coordina- 
tion, and  without  coordination  efficient  administration  is 
impossible. 

The  Revised  Estimate,  or  "Budget,"  the  Result  of  Cooperation 

It  may  be  well  to  state  again  that  it  is  not  intended  to 
imply  by  the  emphasis  placed  on  the  importance  of  the  sales 
estimate  that  the  sales  department  should  determine  the 
policies  of  the  business  as  a  whole.  The  following  discus- 
sion will  show  that  though  the  sales  estimate  is  usually  pre- 
pared originally  by  the  sales  department,  the  sales  depart- 
ment in  its  preparation  should  take  into  consideration  the 
plans  and  possibilities  of  the  other  departments.  In  any 
case,  the  revised  estimate,  or  "budget,"  which  serves  as 
the  basis  for  future  operations,  is  the  result  of  the  coopera- 
tive efforts  of  all  the  functional  departments  of  the  business. 


6o 


BUDGETARY  CONTROL 


It  is  revised  and  modified  by  the  functional  ofiicers  and  the 
budget  committee  before  it  is  adopted  in  its  final  forni. 

The  purpose  of  the  preceding  discussion  is  to  emphasize 
the  need  and  importance  of  the  sales  estimate.  It  is  now 
necessary  to  discuss  its  preparation  and  the  method  by 
which  it  is  used. 

Threefold  Basis  of  the  Sales  Estimate 

The  sales  estimate  is  a  report  which  gives  in  a  sum- 
marized but  comprehensive  form  the  sales  which  the  sales 
department  desires  and  deems  possible  during  the  next 
budget  period.  In  the  preparation  of  this  estimate,  infor- 
mation of  various  kinds  must  be  considered,  which  informa- 
tion may  be  classified  under  the  following  general  headings : 

1.  Knowledge  of  general  plans  and  policies  of  the  business.    Such  in- 

formation is  obtained  from  the  decisions  of  the  executive  offi- 
cers and  the  board  of  directors. 

2.  Knowledge  of  trade  conditions.    Such  information  is  obtained  as 

a  result  of  market  analysis. 

3.  Knowledge  of  the  amount  and  nature  of  previous  sales,  as  shown  by 

the  accounting  records.  Such  information  involves  sales 
analysis  and  comparisons. 

It  is  necessary  to  discuss  each  of  these  briefly. 

I.  The  General  Plan  and  Policies  of  the  Business 

In  most  businesses,  plans  are  made  from  time  to  time 
which  affect  the  sales  policies  and  the  volume  of  sales  of  the 
business.  A  few  examples  will  suffice  to  make  clear  the 
importance  of  considering  such  plans  in  making  the  sales 
estimate. 

In  many  businesses  there  is  a  special  department  called 
by  various  names,  such  as  sales  engineering,  sales  promo- 
tion, sales  development,  or  sales  research  department,  whose 
function  it  is  to  study  sales  possibilities  and  to  recommend 


THE  SALES  BUDGET 


6l 


changes  in  sales  policies  and  methods.  As  a  result  of  such 
recommendations  new  lines  may  be  added ;  old  lines  may  be 
dropped;  new  territories  may  be  entered;  new  agencies  or 
branches  established ;  new  methods  of  distribution  put  into 
effect;  changes  in  prices  or  terms  of  sale  made;  additional 
advertising  carried  on ;  more  salesmen  added ;  and  numerous 
other  changes  made. 

Whether  or  not  a  separate  department  is  maintained  to 
carry  on  work  of  the  sort  mentioned,  such  changes  are  made 
from  time  to  time  by  all  progressive  firms,  and  the  effect  of 
such  changes  must  be  given  careful  consideration  in  the 
preparation  of  the  sales  estimate.  In  some  cases  such 
changes  are  decided  upon  by  the  chief  executive  of  the  sales 
department,  but  since  they  affect  to  some  extent  the  activi- 
ties of  all  the  other  departments,  it  is  customary  for  them 
to  be  considered  by  all  the  functional  executives  before  they 
are  adopted.  In  the  case  of  some  sales  policies  which  will 
vitally  affect  the  business,  it  may  be  necessary  for  the  board 
of  directors  to  judge  if  so  radical  a  change  as  that  suggested 
by  the  program  is  desirable  for  the  business.  In  a  business 
where  proper  methods  of  management  are  followed,  the 
effect  of  new  policies  will  be  considered  before  they  are 
adopted.  Therefore  it  is  not  difficult  to  give  effect  to  these 
policies  in  the  sales  estimate.  The  importance  of  giving 
careful  consideration  to  their  effect  cannot  be  overestimated. 

2.  Market  Analysis 

Although  the  questions  concerning  market  analysis  are 
primarily  problems  of  the  larger  one  of  sales  management, 
they  are  nevertheless  inseparably  interwoven  with  a  con- 
sideration of  budget-making  and  control.  In  fact,  neither 
market  analysis  nor  sales  analysis  can  be  intelligently  con- 
sidered apart  from  the  other.  Each  serv^es  as  a  check  upon 
the  other.    Market  analysis  and  statistical  records  show  to 


62 


BUDGETARY  CONTROL 


what  extent  the  potential  demand  has  been  satisfied  and 
whether  or  not  it  is  profitable  to  try  to  satisfy  it.  As  has 
been  pointed  out  before,  the  purpose  of  making  sales  is  to 
gain  a  profit.  But  not  every  demand  for  goods  is  one  which 
can  be  satisfied  on  a  profitable  basis.  It  is  the  function  of 
accounting  and  statistics  to  assist  in  the  determination  of 
the  results  of  past  sales  and  thus  to  indicate  the  probable 
results  of  anticipated  sales. 

To  mention  all  the  factors  which  must  be  considered  in 
making  an  analysis  of  the  market  in  the  case  of  a  retail, 
wholesale,  or  manufacturing  business  is  of  course  impossible. 
The  buying  power  of  the  community,  as  reflected  in  its 
savings  bank  deposits;  the  industrial  growth  of  the  com- 
munity, as  reflected  in  its  pay-rolls ;  the  condition  of  crops 
and  the  profits  of  the  farmer  and  stock-raiser  in  the  surround- 
ing agricultural  region;  transportation  conditions  in  their 
relation  to  the  delivery  of  goods;  climatic  changes  and  their 
effect  on  seasonable  lines ;  these  and  many  other  general  and 
local  trade  factors  wall  each  have  a  bearing  on  the  sales  to  be 
expected  for  a  retail  store.  Then  the  store  will  have  to  con- 
sider many  local  factors  of  importance  to  itself,  such  as  new 
buildings  and  street  improvements  near  the  store;  fire 
hazards;  relationship  of  management  to  state  officials  with 
reference  to  state  laws  of  employment,  etc. ;  new  forms  of 
taxes  adopted  or  proposed ;  character  of  store  management ; 
and  the  like. 

In  a  wholesale  or  manufacturing  business  many  of  the 
factors  above  mentioned  will  have  to  be  taken  into  account, 
and  in  addition  others  of  a  more  general  nature.  For  in- 
stance, general  industrial  and  agricultural  conditions 
throughout  the  territory  reached  by  the  retailers  or  jobbers 
to  whom  the  company  sells  must  be  considered,  and  in  de- 
ciding on  methods  of  selling  and  advertising,  and  in  estimat- 
ing results,  the  density  and  character  of  the  population  in 


THE  SALES  BUDGET 


63 


both  old  and  potential  territory  must  be  taken  into  account. 
It  will  be  understood  that  the  "business  cycle"  must  be 
given  careful  consideration  in  the  determination  of  the  sales 
possibilities  of  both  a  mercantile  and  a  manufacturing  firm. 
In  some  businesses  it  is  the  function  of  the  sales  engineer- 
ing department,  or  some  other  department  performing  the 
same  function,  to  make  the  market  analysis  and  present  the 
data  which  serve  as  a  basis  for  the  sales  estimate.  In  any 
case  these  data  must  be  available  if  accurate  forecasts  are 
to  be  made.  It  is  beyond  the  scope  of  this  discussion  to 
treat  of  all  the  problems  involved  in  sales  administration 
and  management.  The  purpose  of  the  present  discussion 
is  to  emphasize  the  necessity  for  the  careful  and  scientific 
consideration  by  the  sales  department  of  all  the  factors  which 
may  influence  future  sales,  if  the  sales  department  is  to  pre- 
pare a  sales  estimate  which  will  serve  as  a  proper  basis  for 
coordination  of  departmental  activities. 

3.  Sales  Analysis 

Having  in  mind  that  only  a  few  of  the  usual  factors  in 
sales  management  have  been  mentioned,  it  seems  at  first 
thought  as  if  it  were  impossible  to  use  accounting  records 
and  reports  to  any  advantage  in  estimating  what  the  volume 
and  character  of  sales  are  likely  to  be.  The  outstanding 
fact  is  that  a  sales  program  must  be  made,  and  in  fact  is 
made  in  the  conduct  of  all  businesses.  Even  if  the  presi- 
dent only  "  hopes  to  do  slightly  better  this  period  than  the 
preceding  one,"  the  sales  program  is  the  result  of  taking 
the  revenue  accounts  of  the  last  period  with  an  additional 
margin  of  possibly  5  per  cent.  The  directors  who  ask  their 
officers  to  "hold  your  own  despite  the  decline  in  the  mar- 
ket or  other  conditions,"  are  setting  up  a  very  definite 
standard  of  performance  and  accountability.  The  estimate 
of  sales  is  based  on  the  actual  sa'es  of  the  preceding  period, 


64 


BUDGETARY  CONTROL 


or  periods,  plus  or  minus  certain  amounts  or  percentages. 
This  modification  is  due  to  a  more  or  less  careful  consid- 
eration of  various  general  trade  factors  and  various  trade 
conditions  peculiar  to  the  business  itself. 

In  some  businesses  it  is  the  custom  to  take  past  sales  and 
apply  a  more  or  less  arbitrary  percentage  in  order  to  arrive 
at  the  estimated  sales  of  the  following  period .  This  method 
is  unscientific  and  is  usually  inaccurate,  for  it  does  not  take 
into  account  trade  conditions  or  changes  in  market  policies 
on  the  part  of  the  business,  and  such  changes  occur  almost 
continuously  in  most  businesses.  It  is  highly  important 
that  past  sales  be  considered  very  carefully  in  making  the 
sales  program,  but  it  is  not  wise  to  follow  such  statistics 
slavishly. 

The  sales  accounts  of  a  business  tell  the  owner  what 
past  sales  have  been.  If  the  total  sales  are  credited  to  one 
account  only,  there  is  still  the  very  valuable  analysis  by 
days,  weeks,  and  months,  of  cash  and  accounts  receivable 
gained  by  the  store  through  creating  sales,  although  this 
information  may  not  be  classified  in  a  convenient  form,  and 
so  may  be  difficult  to  obtain.  If  a  proper  analysis  of  sales 
is  maintained  by  means  of  accounting  or  statistical  records, 
there  will  be  available  information  not  only  of  value  in  mak- 
ing the  sales  estimate,  but  also  of  service  to  the  various 
departmental  managers.  Although  it  is  not  safe  to  assume 
without  investigation  that  the  same  ratio  between  various 
classes  of  sales  will  continue  year  after  year,  if  the  past 
tendency  is  known  a  fair  estimate  of  the  future  ratio  can  be 
made.  For  instance,  if  the  sales  analysis  shows  that  for  the 
past  five  years  the  cash  sales  have  averaged  25  per  cent  of 
the  total,  and  the  sales  on  account  75  per  cent,  the  treasurer 
can  usually  assume  that  approximately  the  same  ratio  will 
hold  good  during  the  next  year  unless  there  are  conditions 
which  it  is  known  will  change  the  ratio. 


THE  SALES  BUDGET 


65 


Veirious  Kinds  of  Sales  Information  Desired 

After  the  probable  ratios  between  the  various  classes  of 
sales  are  known,  the  departmental  executives  can  use  them 
in  estimating  the  effect  of  the  proposed  program  on  their 
activities.  To  understand  the  analysis  which  should  be 
made,  it  is  necessary  to  consider  briefly  the  nature  of  the 
information  which  may  be  desired. 

If  the  problem  is  to  estimate  the  sales  for  a  retail  store 
for  the  three  months  beginning  June  i,  the  first  question 
asked  of  the  accountant  is  likely  to  be:  What  were  the 
sales  of  last  summer  by  days  and  weeks?  The  representa- 
tive, or  representatives,  of  the  sales  department  who  are 
responsible  for  the  preparation  of  the  sales  estimate  asks 
this  in  order  to  be  able  to  make  an  estimate  for  the  current 
period.  The  sales  department,  in  turn,  must  answer  the 
question  of  the  amount  of  sales  anticipated  for  this  summer. 
In  the  preparation  of  the  sales  estimate,  this  information 
must  be  obtained  and  made  available.  The  merchandise 
manager  asks  the  question  of  the  sales  department  in  order 
that  he  may  be  equipped  to  fix  delivery  dates  in  his  con- 
tracts with  manufacturers  and  wholesalers.  The  operating 
superintendent  asks  it  because  he  must  estimate  the  number 
of  employees  required  through  the  normal  vacation  period. 
The  treasurer  asks  it  because  he  must  finance  the  purchase 
invoices,  the  store  pay-rolls,  etc.  Even  the  finance  com- 
mittee of  the  board  of  directors  may  ask  it  if  they  are  plan- 
ning certain  changes  in  the  financial  plans  of  the  company. 

In  addition  to  this  information,  each  officer  may  ask  for 
data  on  last  year's  sales  from  the  viewpoint  of  his  particular 
responsibility.  The  operating  superintendent  asks,  "What 
percentage  of  sales  last  summer  were  counter  sales?  What 
percentage  of  sales  were  over  the  telephone?"  The  treas- 
urer asks  for  data  as  to  cash  sales,  sales  on  monthly  accounts, 
and  instalment  sales.  The  traffic  manager  asks  for  the 
5 


66 


BUDGETARY  CONTROL 


amount  of  sales  to  out-of-town  customers  by  express  and 
by  freight.  These  and  many  other  questions  of  a  similar 
nature  will  be  asked  of  the  accounting  department,  and,  in 
order  to  be  able  to  answer  them,  a  proper  analysis  and  classi- 
fication of  sales  data  is  necessary. 

Classification  of  Sales  Data 

No  arbitrary  classification  of  sales  data  can  be  given,  {or 
the  analysis  and  classification  made  is  determined  by  the 
information  desired  by  the  various  functional  managers. 
But  it  is  safe  to  say  that  in  planning  for  the  future  the  offi- 
cers and  managers  will  desire  sales  to  be  classified  in  some  or 
all  of  the  following  ways : 

1.  By  commodity  or  department 

2.  By  terms  of  sales 

3.  By  method  of  sale 

4.  By  method  of  delivery 

5.  By  territory  of  customers 

6.  By  salesmen 

7.  By  vohime  of  sales  to  individual  customers 

8.  By  nature  of  customers 

9.  By  rush  vs.  normal  deliveries 

The  purpose  of  each  of  these  classifications  should  be  evi- 
dent to  the  reader. 

In  a  manufacturing  business  a  shorter  classification  may 
be  required.  This  is  due  to  the  fact  that  it  handles  and  sells 
its  commodities  more  directly  than  a  trading  company. 
Where  goods  are  sold  in  large  quantities,  as  is  usually  the 
case  in  the  disposition  of  products  by  a  manufacturing  busi- 
ness, the  problems  of  selling  are  less  complicated.  In  such 
a  business  sales  may  be  classified  as  follows : 

1.  By  commoaities  or  groups 

2.  By  territories 

3.  By  salesmen 

4.  By  customers 


1 


THE  SALES  BUDGET 


67 


In  a  manufacturing  business  the  terms  of  sale,  method  of 
sale,  and  method  of  delivery  are  usually  uniform  for  all 
classes  sold.  Where  this  is  true,  no  classification  to  indicate 
these  is  necessary. 

The  classifications  of  sales  stated  above  are  intended  to 
be  suggestive  rather  than  all-inclusive.  They  are  indica- 
tive of  what  may  be  done  in  the  classifying  of  sales  in  order 
to  make  available  information  for  the  preparation  of  the 
sales  estimate  and  for  the  use  of  the  departmental  managers 
in  making  their  plans. 

Terms  in  Which  Estimate  Is  Made 

The  terms  in  which  the  estimate  should  be  made  are 
dependent  on  the  nature  of  the  business  and  the  purpose  for 
which  the  estimate  is  to  be  used.  In  the  past,  estimates  of 
sales  and  purchases  and  expenses  have  been  made  by  some 
businesses  for  the  purpose  of  financial  control  only.  As  a 
consequence  they  have  been  made  in  terms  of  value.  For 
the  purposes  of  financial  control  all  estimates  must  be  stated 
in  terms  of  value;  but  for  the  purpose  of  sales,  production, 
and  purchases  control,  estimates  must  be  stated  in  terms  of 
physical  quantities  and  not  in  terms  of  value  only.  There 
are  possibly  a  few  cases  where  sales  and  purchasing  control 
may  be  effected  in  terms  of  value,  but  these  cases  are  rare. 

In  a  manufacturing  business  it  is  essential  that  the  sales 
estimate  be  made  in  terms  of  physical  quantities,  for  pro- 
duction orders  are  issued  for  a  certain  number  of  each  item  of 
goods  produced  and  not  in  terms  of  dollars  and  cents.  It  is 
not  enough  for  the  production  department  to  know  that  the 
estimated  sales  for  the  budget  period  are  $3,000,000.  It 
must  know  how  many  hundred  of  each  of  the  items  which 
the  company  offers  for  sale  will  be  sold  during  the  period,  so 
it  will  know  how  many  must  be  produced  to  meet  the  sales 
requirements.    It  is  necessary  that  the  sales  estimate  not 


68 


BUDGETARY  CONTROL 


only  state  the  sales  to  be  made,  in  terms  of  physical  quanti- 
ties, but  it  is  also  necessary  that  it  state  separately  the  sales 
of  each  item  of  goods  which  is  offered  for  sale.  Some  com- 
panies make  estimates  in  terms  of  sales  classes  or  groups. 
These  are  of  little  value  from  the  viewpoint  of  coordinating 
sales  and  production. 

Planning  Sales  in  Terms  of  Items 

Sales  orders  are  made  in  terms  of  particular  items  of 
commodities,  and  if  these  items  are  to  be  available,  produc- 
tion must  be  planned  in  terms  of  these  items.  A  factory 
may  have  a  large  inventory  and  yet  be  unable  to  fill  sales 
orders  if  the  particular  items  called  for  by  these  orders  are 
not  on  hand.  To  make  the  sales  estimate  serve  as  a  basis 
for  the  coordination  of  sales  and  production,  it  is  essential 
that  the  planning  of  sales  be  in  terms  of  items  and  not  in 
terms  of  values  or  groups  or  classes. 

In  most  cases  the  same  principle  holds  true  in  the  retail 
or  wholesale  store.  A  customer  does  not  want  a  pair  of 
shoes  but  the  pair  of  shoes  of  his  particular  size  and  shape. 
In  order  that  the  merchant  may  know  how  many  customers 
want  each  particular  make,  size,  and  style  and  that  he  may 
procure  the  goods  in  advance  to  meet  these  demands,  it  is 
necessary  to  have  records  which  will  give  such  information 
with  reference  to  past  sales,  and  will  furnish  a  basis  for  mak- 
ing accurate  estimates  of  future  requirements.  Thus  it  is 
in  all  lines  of  merchandise — the  demands  of  the  customers 
call  for  particular  items,  and  the  sales  and  purchase  budgets 
must  be  made  accordingly.  It  is  of  course  true  that,  in  the 
case  of  goods  subject  to  wide  changes  in  fashion,  estimates 
by  items  cannot  be  made  accurately.  But  even  in  this  case 
past  statistics  will  show  a  fair  indication  of  the  customers' 
demands  for  different  styles  and  kinds. 

The  necessity  for  making  the  sales  estimate  in  terms  of 


t 


THE  SALES  BUDGET 


69 


items  makes  the  task  of  preparing  the  estimate  much  more 
complex  in  many  cases.  The  different  items  of  merchandise 
sold  by  some  firms  run  into  the  thousands.  To  estimate 
sales  and  plan  production  in  connection  with  each  of  these 
items  is  a  very  difficult  problem.  In  some  cases  the  number 
of  items  may  be  so  great  that  this  is  well-nigh  impossible. 

Under  such  conditions  some  method  must  be  devised 
which  will  obtain  the  necessary  results  without  the  incur- 
rence of  prohibitive  labor.  In  most  cases  a  study  of  the 
sales  of  a  firm  handling  thousands  of  items  will  show  that  the 
bulk  of  its  sales  is  composed  of  a  comparatively  few  items 
and  that  the  remainder  are  slow-moving  items  of  which  the 
number  of  sales  are  few.  This  may  make  it  possible  to  select 
a  list  of  "significant"  items  which  will  contain  those  which 
constitute  the  bulk  of  the  sales.  In  a  recent  case  on  which 
the  author  was  employed,  it  was  found  that  of  20,000 
items,  682  constituted  approximately  75  per  cent  of  the 
total  sales. 

Use  of  "Key"  Items  in  Sales  Estimates 

In  some  cases  it  is  found  that  there  are  certain  "key" 
items  of  which  the  fluctuations  in  sales  govern  the  fluctua- 
tions in  a  number  of  similar  items.  For  instance,  there  may 
be  a  group  of  items  which  are  the  same  except  for  size,  and 
there  may  be  one  particular  size  in  the  group  for  which  there 
is  the  greatest  demand.  It  may  be  found  that  the  sales  of 
the  less  popular  sizes  fluctuate  year  by  year  in  proportion  to 
the  fluctuation  in  the  sales  of  the  most  popular  size ;  and  if 
this  condition  can  be  shown  to  be  approximately  correct 
it  is  then  necessary  to  have  the  sales  department  estimate 
only  the  sales  of  the  "  key  "  items,  the  statistical  department 
estimating  the  sales  of  the  remaining  items.  It  is  only  in 
certain  businesses  handling  certain  lines  of  merchandise  that 
there  exists  a  probability  of  such  a  condition  arising,  but 


70 


BUDGETARY  CONTROL 


where  it  does  arise  it  greatly  facilitates  the  preparation  of 
the  sales  estimate. 

When  it  is  possible  to  select  significant  or  key  items,  the 
sales  and  production  budgets  may  be  made,  in  terms  of 
items,  for  the  items  on  the  significant  list.  The  remaining 
items  can  be  grouped  by  classes  and  the  budgets  prepared 
on  them  in  terms  of  classes.  Although  the  budgets  on  the 
groups  will  be  in  most  cases  unsatisfactory  from  the  view- 
point of  coordination  of  sales  and  production,  this  is  not  of 
so  great  importance  for  these  items,  which  have  a  low  turn- 
over and  are  slow-moving,  inasmuch  as  it  is  not  difficult  to 
provide  sufficient  inventory  to  meet  the  sales.  By  a  proper 
system  of  inventory  control,  excess  quantities  can  be 
avoided.  For  the  purpose  of  the  financial  budget,  the 
group  budget  on  the  non-significant  items  will  usually  serve 
satisfactorily. 

It  is  not  intended  to  imply  by  the  foregoing  discussion 
that  budgets  prepared  in  terms  of  classes  or  groups  of  items 
are  desirable.  It  is  intended  only  to  suggest  that  this  is 
one  method  of  procedure  when  the  items  sold  by  a  company 
are  exceedingly  numerous.  If  such  a  plan  is  followed,  it 
will  usually  be  found  expedient  to  add  gradually  more  and 
more  items  to  the  significant  list  as  the  work  proceeds.  If 
such  a  study  is  begun,  it  will  usually  result  in  the  elimination 
of  many  of  the  "non-significant"  items  which  it  will  be 
found  are  unprofitable  and  unnecessary.  In  the  end  this 
process  will  result  in  the  proper  budgeting  of  all  items. 


ft 


CHAPTER  VI 


THE  SALES  BUDGET  (Continued) 

Responsibility  for  Preparing  the  Sales  Estimate 

As  stated  in  the  preceding  chapter,  the  sales  estimate  is 
prepared  by  the  sales  department.  As  to  which  particular 
unit  of  the  sales  organization  should  be  responsible  for  its 
preparation,  an  arbitrary  rule  cannot  be  formulated.  In 
each  case  the  organization  of  the  company  and  its  selling 
methods  must  be  taken  into  consideration. 

In  a  department  store  the  departmental  managers  are 
usually  held  responsible  for  the  preparation  of  the  depart- 
mental estimates,  and  these  are  combined  by  the  merchan- 
dise manager  to  make  the  estimate  for  the  entire  business. 
The  departmental  manager  of  course  will  consult  with  his 
assistants  in  the  preparation  of  his  estimate. 

In  a  wholesale  or  manufacturing  business  which  employs 
traveling  salesmen,  each  salesman  may  be  asked  to  make 
an  estimate  of  the  sales  in  his  territory  for  the  budget  period. 
Such  estimates  will  of  course  have  to  be  checked  very  closely 
and  revised  by  the  central  sales  office  in  the  light  of  the  data 
which  it  should  ha\'e  available. 

In  a  business  which  sells  its  products  through  branches, 
each  branch  may  be  requested  to  make  an  estimate  of  its 
sales.  These  estimates,  like  those  of  the  salesmen,  should 
be  carefully  checked  by  the  central  sales  office. 

When  either  salesmen  or  branches  are  requested  to  make 
an  estimate  of  their  sales,  they  should  be  provided  with  a 
record  of  their  sales  for  one  or  more  past  periods,  in  order  to 
be  able  to  use  these  data  in  making  an  estimate  of  future 
sales. 


71 


72 


BUDGETARY  CONTROL 


Those  who  favor  the  making  of  estimates  by  salesmen 
and  branches  contend  that  those  in  closest  touch  with  the 
customers  are  best  able  to  judge  future  demands.  There 
are  some  companies,  however,  who  will  not  rely  at  all  upon 
the  estimates  of  the  sales  force.  Instead,  they  favor  the 
collection  of  data  by  the  central  sales  office  and  the  employ- 
ment of  special  investigators  who  make  a  survey  of  the  sales 
territory  and  report  on  possibilities.  Using  the  data  with 
reference  to  population,  industrial  conditions,  etc.,  and  the 
reports  of  the  special  investigators,  in  connection  with  past 
sales,  they  formulate  the  sales  estimate.  In  some  cases, 
after  the  estimate  is  prepared  by  the  central  office,  it  is  sent 
to  the  branches  or  to  the  salesmen  for  criticism. 

Relation  of  Inventory  Requirements  to  Sales  Estimate 

If  a  business  has  branches  which  carry  an  inventory  of 
merchandise,  a  further  complication  arises  in  connection 
with  estimating  their  requirements,  since  the  amount  de- 
sired by  them  from  the  parent  company  is  dependent  not 
only  upon  their  anticipated  sales,  but  also  upon  the  condi- 
tion of  their  stocks.  Their  inventories  maybe  below  normal 
on  some  items  and  show  an  excess  on  others.  This  condi- 
tion is  especially  apt  to  exist  at  the  time  a  system  of  budget- 
ary control  is  installed.  After  the  system  becomes  effective, 
material  excesses  or  shortages  in  inventories  should  be 
eliminated,  except  in  rare  cases. 

Each  branch  must  of  necessity  report  the  condition  of  its 
inventories  for  each  budget  period,  whether  or  not  it  is  held 
responsible  for  initiating  the  sales  estimate.  Since  the  sales 
estimate  must  be  submitted  previous  to  the  beginning  of  the 
budget  period  in  order  that  the  production  budget  or  pur- 
chase budget  may  be  prepared  for  use  by  the  beginning  of 
the  period,  it  is  necessary  for  each  branch  or  selling  unit 
which  carries  an  inventory  to  estimate  its  inventory  at  both 


THE  SALES  BUDGET 


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74 


BUDGETARY  CONTROL 


the  beginning  and  the  end  of  the  budget  period.  This  of 
course  adds  another  difficulty  to  the  making  of  an  accurate 
estimate.  To  illustrate  more  clearly  the  nature  of  the  in- 
formation which  the  branch  or  selling  unit  must  submit,  a 
typical  illustration  may  be  taken. 

The  X  Manufacturing  Company  distributes  the  major 
part  of  its  product  through  its  branches,  but  sells  some  goods 
to  jobbers.  The  branches  make  the  principal  part  of  their 
sales  from  stock  which  they  carry,  but  take  some  orders 
which  are  shipped  direct  from  the  factory.  The  general 
sales  office  submits  to  the  branches  a  form  ruled  as  shown 
in  Figure  2. 

The  first  column  will  be  filled  in  by  the  general  office. 
If  the  detailed  sales  records  are  kept  at  the  general  office,  it 
also  will  fill  in  the  second  column.  If,  however,  these 
records  are  kept  at  the  branch,  the  branch  will  fill  in  this 
column.  The  remaining  columns  are  filled  in  by  the  branch. 
Column  (6)  equals  the  sum  of  columns  (3)  and  (4)  minus 
column  (5).  Column  (8)  equals  the  sum  of  columns  (6) 
and  (7).  In  filling  in  column  (4),  it  is  necessary  for  the 
branch  to  have  in  mind  some  such  terms  as  a  "thirty-day" 
stock  or  a  "sixty-day  "  stock.  After  the  estimated  sales  for 
the  period  are  determined,  it  is  only  a  mathematical  proc- 
ess to  obtain  the  estimated  inventory  at  the  end.  The 
foregoing  illustration  is  given  in  order  to  indicate  some  of 
the  problems  which  may  arise  in  the  making  of  an  accurate 
sales  estimate. 

Revision  of  Sales  Estimate  According  to  Production 

After  the  sales  estimate  is  submitted  by  the  unit  of  the 
sales  department  which  is  held  responsible  for  its  prepara- 
tion, it  should  be  studied  by  the  staff  officers  and  revised  in 
the  light  of  their  information  and  judgment.  In  the  case 
of  a  manufacturing  industry,  it  must  be  revised  in  the  light 


I 


THE  SALES  BUDGET 


75 


of  production  capacity.  It  is  useless  to  formulate  a  sales 
program  which  is  beyond  the  capacity  of  the  production 
department  to  satisfy.  Consequently,  data  must  be  ob- 
tained which  will  show  production  capacity.  o  r  der  for 
this  to  be  accurate  and  comprehensive,  it  is  necessary  to 
obtain  data  which  wall  show  machine  capacity.  This  neces- 
sitates the  preparation  of  a  card  for  each  machine  used  in 
the  process  of  manufacturing,  showing  the  operations  per- 
formed on  the  machine  and  its  capacity  in  the  performance 
of  these  operations.  It  is  then  possible  to  determine 
whether  the  quantities  called  for  by  the  sales  estimate  can 
be  produced.  If  not,  it  is  necessary  to  determine  which 
items  should  be  reduced  or  eliminated. 

Revision  of  Sales  Estimate  in  Terms  of  Profit 

Another  important  factor  in  deciding  the  desirability  of 
the  sales  program  proposed  by  the  sales  department  is  the 
estimated  profit.  It  is  desirable  that  the  profit  to  be  ob- 
tained by  the  sale  of  each  item  called  for  by  the  sales  esti- 
mate be  determined,  if  possible.  It  is  undesirable  to  produce 
and  sell  an  article  which  does  not  yield  a  satisfactory  profit 
if  it  can  be  prevented.  Sometimes,  however,  because  of 
competitive  conditions  it  is  necessary  to  sell  certain  items 
in  order  to  meet  sales  demands  for  a  complete  line  of  articles. 
For  instance,  in  the  sale  of  valves,  dealers  find  it  necessary 
to  carry  several  sizes  in  order  to  meet  the  demands  of  their 
customers.  Some  manufacturers  produce  all  these  sizes 
so  that  other  manufacturers,  in  order  to  meet  the  demands 
of  the  dealers,  may  be  required  to  carry  a  complete  line  for 
fear  the  dealer  will  place  his  order  with  the  manufacturer 
from  whom  he  can  obtain  a  complete  line.  That  a  complete 
line  may  be  maintained,  it  may  be  necessary  for  the  manu- 
facturer to  produce  certain  sizes  which  he  is  unable  to  pro- 
duce and  sell  at  competitive  prices  without  incurring  a  loss. 


76 


BUDGETARY  CONTROL 


In  the  revision  of  the  sales  estimate  in  terms  of  profit,  it 
is  necessary  to  give  careful  consideration  to  the  problem  of 
providing  complete  lines,  so  that  items  may  not  be  elimi- 
nated which  will  result  in  decreased  sales  of  other  items. 
On  the  other  hand,  the  sales  department  has  a  tendency  to 
overemphasize  the  necessity  for  complete  lines,  and  care 
must  be  exercised  to  prevent  the  carrying  of  too  many  un- 
profitable items.  There  is  considerable  agitation  at  the 
present  time  for  standardization.  It  is  to  be  hoped  that 
this  movement  will  develop  and  will  result  in  the  elimination 
of  many  specialties,  especially  in  the  case  of  goods  which  are 
adapted  to  standardization.  Such  standardization  will 
greatly  simplify  the  problem  of  budgetary  control. 

Consideration  of  Maximum  Gross  Profit 

In  revising  the  sales  estimate  in  terms  of  profit  it  is 
necessary  to  consider  not  only  the  profit  which  has  resulted 
from  past  operations,  but  also  the  probable  profit  which  will 
result  from  the  anticipated  operations.  Changes  in  method 
or  volume  of  production,  as  well  as  changes  in  method  or 
volume  of  sales,  may  affect  materially  the  profit  obtained. 
In  order  to  estimate  more  accurately  the  effect  of  these 
changes  in  production  or  sales  it  is  desirable  to  consider  the 
cost  of  production  and  selling  and  administrative  expense 
and  the  effect  of  the  new  program  on  these  items.  It  is 
imperative  that  careful  consideration  be  given  to  these  fac- 
tors in  the  revision  of  the  sales  estimate. 

The  sales  program  must  provide  for  the  maximum  profit 
that  trade  conditions  will  permit  consistent  with  the  perma- 
nency of  the  business.  Here  is  one  of  the  vital  points  in 
making  over  the  sales  estimate  of  volume  into  a  sales  pro- 
gram. The  management  must  decide  not  only  what  in- 
crease in  business  is  desired,  but  also  what  volume  of  busi- 
ness can  be  had  at  a  maximum  gross  profit  of  selling  price 


THE  SALES  BUDGET 


77 


to  the  customer  over  the  purchase  price  or  cost  of  produc- 
tion. Consequently  the  estimated  volume  of  each  line, 
even  of  each  class  and  kind  of  goods,  must  be  re-estimated 
at  the  volume  that  will  produce  the  greatest  amount  of 
gross  profit.  Obviously  it  is  better,  from  the  standpoint  of 
gross  profits,  to  plan  to  sell  $120,000  of  merchandise  at  30 
per  cent  gross  profit,  than  it  is  to  sell  $140,000  at  25  per  cent. 

Revision  of  Sales  Estimate  in  Terms  of  Selling  Administrative 
Expense 

It  is  to  be  kept  in  mind  that  gross  profit  is  not  the  only 
consideration.  Handling  cost  may  more  than  offset  gross 
profit.  There  is  more  net  profit  in  selling  $100,000  of  mer- 
chandise over  the  counter  for  cash  at  a  gross  profit  of  15  per 
cent  and  an  operating  and  overhead  expense  of  1 1  per  cent, 
than  there  is  in  selling  $200,000  by  the  instalment  plan  at  a 
gross  profit  of  27.5  per  cent  and  an  operating  and  overhead 
expense  of  26.2  per  cent.  It  follows  that  the  re-estimated 
sales  must  be  gone  over  again  from  the  standpoint  of  ex- 
pense. Sometimes  it  is  difficult  to  obtain  accurate  informa- 
tion with  reference  to  the  expense  of  selling  different  lines 
or  items.  When  possible,  such  statistical  analysis  should 
be  maintained  as  will  provide  this  information.  In  some 
cases  the  cost  of  obtaining  such  statistics  is  prohibitive. 
It  is  then  necessary  to  resort  to  tests  and  estimates.  From 
time  to  time  studies  can  be  made,  and  these  may  serve  as 
the  basis  for  drawing  up  fairly  accurate  estimates.  These 
estimates,  in  turn,  may  be  used  to  judge  the  profit  possibili- 
ties of  various  lines  or  classes. 

Revision  of  Sales  Estimate  According  to  Financial  Requirements 

In  the  execution  of  sales  and  production,  finances  are 
required.  An  important  factor,  therefore,  which  must  be 
given  careful  consideration  in  the  formulation  of  the  sales 


78 


BUDGETARY  CONTROL 


program,  is  the  financial  requirements.  There  are  two 
ways  in  which  the  financial  requirements  may  be  considered. 
After  the  sales  estimate  has  been  revised,  taking  into  con- 
sideration production  capacity,  profits,  and  the  like,  the 
amount  of  capital  required  to  execute  this  program  may  be 
estimated.  If  this  amount  is  in  excess  of  that  which  the 
financial  resources  of  the  business  will  permit  tobe  expended, 
it  is  necessary  to  revise  the  sales  program.  In  making  this 
revision  the  various  factors  previously  discussed  will  be 
taken  into  consideration. 

Another  method  of  considering  financial  requirements 
is  in  connection  with  the  revision  of  the  original  sales  esti- 
mate. The  amount  of  capital  required  to  finance  each 
item  of  merchandise  listed  on  the  sales  estimate  may  be 
indicated  and  this  factor  considered  in  deciding  which  items 
to  reduce,  in  case  reduction  is  necessary.  In  any  case,  after 
an  estimate  has  been  made  of  the  activities  of  all  the  depart- 
ments of  the  business,  it  is  necessary  to  prepare  an  estimate 
of  receipts  and  disbursements,  based  on  the  departmental 
estimates,  and  to  revise  the  departmental  estimates  if 
necessary,  to  bring  them  into  harmony  with  a  workable 
financial  program.  The  process  involved  in  the  making 
of  the  financial  budget  will  be  discussed  in  Chapters 
XIX  and  XX. 

Formulation  of  the  Sales  Program 

In  the  previous  discussion  the  most  important  factors 
which  must  be  considered  in  the  revision  of  the  sales  esti- 
mate have  been  explained.  It  should  be  realized,  of  course, 
that  no  attempt  has  been  made  to  treat  of  all  the  factors 
which  may  need  to  be  considered  in  particular  cases.  If 
the  sales  estimate  is  considered  and  revised  in  the  manner 
suggested,  the  result  will  be  the  formulation  of  a  sales  pro- 
gram based  on  the  following: 


THE  SALES  BUDGET 


79 


1.  Past  sales  as  reflected  in  the  sales  accounts  of  previous  years. 

2.  The  general  plans  and  policies  of  the  business  as  reflected  by  de- 

cisions of  the  executive  officers. 

3.  Trade  conditions  as  determined  by  the  study  and  research  of  the 

sales  department. 

4.  The  judgment  of  the  sales  unit  (or  units),  which  makes  the  original 

estimate. 

5.  The  judgment  of  the  central  sales  office,  which  reviews  the  original 

estimates  and  makes  such  changes  as  it  deems  necessary. 

6.  The  production  or  purchasing  capacity  of  the  business  as  reflected  in 

the  production  and  purchase  estimate. 

7.  The  gross  profit-earning  capacity  of  the  different  lines  or  items. 

8.  The  selling  and  administrative  cost  involved  in  handling  different 

lines  or  items. 

9.  The  financial  requirements  of  the  program  contemplated. 

10.  The  coordination  of  all  the  departmental  estimates  into  a  well- 

rounded  program  for  the  business  as  a  whole. 

11.  The  sales  budget,  showing  the  volume  of  operations  which  the 

sales  department  is  expected  to  perform,  based  on  the  budget 
of  the  business  as  a  whole. 


The  process  of  making  the  sales  program  is  not  a  simple 
one.  Rather  a  sales  program  must  be  thought  of  as  a  com- 
bination of  several  estimates.  It  is  a  statement  of  past 
experience  modified  by  future  plans,  which  are  in  turn  modi- 
fied by  trade  conditions. 


Additional  Factors  in  Determining  Sales  Program 

Many  factors  have  to  be  considered  in  determining  the 
proper  sales  program.  In  the  case  of  a  new  business  the 
ideal  sales  program  may  be  one  that  plans  for  all  the  sales 
that  trade  conditions  will  permit,  the  only  restriction  im- 
posed by  the  owner  being  that  no  line  may  be  handled  at  a 
net  loss.  Once  a  business  is  well  established,  however,  it  is 
not  likely  that  this  will  be  the  sales  program  adopted.  Ex- 
perience will  show  that  some  lines  can  be  handled  with 
greater  profit  than  others,  because  of  the  fact  that  the  loca- 


8o 


BUDGETARY  CONTROL 


tion  attracts  a  certain  class  of  customers  whose  general 
demands  are  for  these  profitable  lines.  Furthermore,  cer- 
tain of  the  personnel  of  the  store  will  show  greater  aptitude 
in  one  or  more  lines.  The  obvious  correction  in  this  case  is 
to  strengthen  the  personnel,  although  that  may  be  a  matter 
of  years  of  development.  Thus,  in  many  ways  the  estab- 
lished business  may  come  to  have  a  personality,  a  policy,  a 
class  of  trade,  a  place  of  its  own  that  can  be  deflected  only 
by  degrees,  and  this  has  an  important  bearing  on  its  sales 
program. 

Since  so  many  factors  have  to  be  considered  in  the  for- 
mulation of  the  sales  program,  it  is  possible  for  it  to  forecast 
only  approximately  the  operations  of  the  sales  department. 
Consequently  the  sales  program  must  not  be  regarded  as  an 
arbitrary  rule  or  regulation,  or  as  an  unchangeable  order  to 
do  certain  definite  things.  A  real  sales  program  is  a  state- 
ment of  profits  that  seem  possible  under  conditions  so  far 
as  conditions  can  be  foreseen.  The  form  of  the  statement  is 
in  the  tangible  and  understandable  terms  of  estimated  sales, 
but  the  purpose  and  meaning  of  the  program  is  to  arrive  at 
net  profit  results.  If  conditions  change  after  the  sales  pro- 
gram is  set  up,  then  the  sales  program  will  be  changed  just 
so  far  as  the  contracts  and  decisions  made  under  the  pro- 
gram can  be  changed.  In  order  to  eff^ect  these  changes,  a 
proper  system  of  reports  which  will  serve  as  a  basis  for  con- 
trol of  the  sales  budget  is  necessary. 

Control  over  the  Sales  Budget 

As  suggested  in  the  preceding  paragraph,  the  sales  budget 
is  a  preliminary  statement  of  the  anticipated  operations  of 
the  sales  department.  Other  departments,  by  means  of 
their  budgets,  attempt  to  coordinate  their  activities  with 
those  of  the  sales  department,  as  shown  by  the  sales  budget. 
As  the  budget  period  proceeds,  it  is  necessary  to  take  into 


THE  SALES  BUDGET 


8l 


consideration  the  variation  of  the  actual  operations  of  the 
sales  department  from  its  estimated  operations.  It  is 
necessary  that  a  comparison  be  made  at  frequent  intervals 
in  order  to  determine  the  amount  of  this  variation,  so  that 
revisions  may  be  made  in  the  sales  budget  for  the  remainder 
of  the  budget  period,  provided  the  comparison  indicates 
that  such  a  revision  is  necessary. 

Effect  of  Revision  of  Sales  Budget  on  Other  Budgets 

After  the  sales  budget  is  revised,  it  is  necessary  to  revise 
the  other  budgets  which  are  affected  thereby.  For  instance, 
a  sales  budget  may  be  made  for  the  first  three  months  of  the 
year,  and  a  production  budget  prepared  to  meet  the  sales 
program.  At  the  end  of  January  a  comparison  may  show 
that  sales  made  during  the  month  are  50  per  cent  less  than 
the  estimated  sales,  and  indications  are  that  a  like  decrease 
will  take  place  in  February.  The  sales  budget  should  then 
be  revised  and  the  production  and  financial  budgets  changed 
to  correspond,  if  such  changes  are  possible.  In  some  cases 
commitments  may  have  been  made  which  make  a  complete 
revision  of  the  other  budgets  impracticable.  At  least  some 
revision,  however,  is  usually  possible.  In  the  same  manner 
comparisons  should  be  made  in  connection  with  the  other 
budgets,  for  if  any  of  these  changes  are  found  necessary, 
they  may  make  a  revision  of  the  sales  budget  necessary. 
For  instance,  if  the  production  program  had  fallen  down,  it 
may  be  necessary  to  decrease  the  sales  budget  because  of 
the  inability  to  fill  orders. 

Reports  from  Sales  Units 

In  order  to  make  a  revision  of  the  sales  budget,  it  is 
necessary  to  have  regular  reports  from  the  sales  departments 
showing  what  the  sales  have  been.  Usually  these  reports 
are  made  monthly.    If  there  are  several  units  of  the  sales 

6 


82 


BUDGETARY  CONTROL 


department  making  sales  independently  of  the  central  sales 
office,  it  is  necessary  to  have  a  separate  report  from  each  of 
these  units.  For  instance,  if  a  business  has  ten  branches, 
each  making  sales  from  its  own  stock,  it  will  be  necessary  to 
ha\  e  reports  from  each  of  these  branches  showing  the  sales 
made,  in  order  that  the  correctness  of  the  original  estimate 
can  be  judged  and,  if  necessary,  revisions  made. 

Sales  Orders  vs.  Shipments 

In  making  a  comparison  between  sales  and  estimated 
sales  it  is  necessary  to  interpret  "sales"  to  mean  orders  re- 
ceived rather  than  goods  shipped.  Otherwise  there  may 
be  a  wide  variation  between  the  sales  made  and  the  sales 
estimated,  which  is  not  due  to  the  fact  that  the  original 
estimate  was  incorrect.  The  goods  may  not  have  been 
shipped  because  of  the  failure  of  the  purchasing  department 
or  the  production  department  to  supply  the  goods.  If  the 
sales  department  obtained  the  orders,  it  has  fulfilled  its 
function.  In  revising  the  sales  budget  it  is  also  improper  to 
consider  shipments,  since  it  is  the  orders  received,  and  not 
the  shipments  made,  which  indicate  the  possibilities  for 
the  remainder  of  the  period.  In  revising  the  production 
budget  it  will  be  necessary  to  consider  the  shipments  in  order 
to  determine  the  shortage  or  the  excess  existing.  In  con- 
sidering the  orders  received  for  the  purpose  of  comparing 
sales  with  estimated  sales  it  is  necessary  to  exclude  those 
received  for  future  delivery. 

Method  of  Revising  Sales  Estimate 

In  case  it  is  found  necessary  to  revise  the  sales  estimate 
because  of  a  falling  off  of  orders,  it  is  possible  to  determine 
which  items  should  be  reduced,  for  the  orders  will  be  classi- 
fied by  items  and  the  different  items  will  be  changed  in  pro- 
portion to  the  orders  received  for  that  item.    In  case  the 


1 


THE  SALES  BUDGET 


83 


sales  budget  must  be  revised,  because  of  a  change  in  some 
other  budget,  such  as  the  production  budget  or  the  financial 
budget,  it  is  necessary  to  decide  which  items  on  the  sales 
budget  should  be  changed.  Some  firms  list  the  items  on 
the  budget  on  a  priority  basis.  In  case  some  items  must  be 
reduced  due  to  revisions  in  other  budgets,  the  reduction  is 
made  on  the  last  item  on  the  list.  If  an  increase  seems  de- 
sirable, the  first  item  on  the  list  is  increased.  The  use  of 
the  priority  list  is  of  more  significance  in  the  case  of  some 
budgets  than  it  is  in  connection  with  the  sales  budget.  For 
instance,  in  the  case  of  the  plant  and  equipment  budget  it 
is  a  very  practicable  method  of  providing  for  a  revision. 

Source  of  Information  Used  in  Formulating  and  Controlling  the 
Sales  Budget 

It  is  not  always  practicable  or  feasible  to  obtain  from 
the  formal  accounting  records  all  the  information  needed  to 
serve  as  a  basis  for  formulating  or  controlling  the  sales 
budget.  A  considerable  part  of  such  information  may  be 
obtained  from  statistical  records  kept  in  the  various  depart- 
ments, or  it  may  be  obtained  from  a  central  statistical  de- 
partment. The  majority  of  up-to-date  sales  departments 
are  constantly  gathering  statistics  which  will  ser\'e  as  a  basis 
for  forecasting  future  sales.  In  many  cases  a  special  depart- 
ment is  maintained  for  this  purpose.  These  data  are  useful 
in  making  the  sales  estimate.  The  operating  department 
may  keep  a  record  of  the  method  of  delivery ;  the  advertising 
manager  may  have  the  sales  tickets  tabulated  in  his  ofiice 
to  indicate  sales  by  territories;  other  officials  may  record 
other  data  which  they  need. 

In  many  businesses  tabulating  machines  are  used  to 
collect  the  statistical  data  needed  by  the  various  depart- 
ments. By  means  of  cards  which  are  punched  to  indicate 
various  classifications  of  data  and  which  are  then  sorted 


84 


BUDGETARY  CONTROL 


and  assembled  it  is  possible  to  obtain  various  kinds  of  data. 
In  case  considerable  statistical  information  is  necessary  the 
tabulating  machines  are  desirable.  In  any  case  the  account- 
ing records  can  provide  quite  useful  analyses  if  these  records 
are  properly  constructed  and  operated,  the  principal  obstacle 
to  this  being  the  conception  of  bookkeeping  as  a  science  of 
formulas  for  the  all  important  purpose  of  arriving  at  net 
profit  or  loss.  Once  a  set  of  revenue  accounts  is  rightly 
considered  as  a  continuing  analysis  of  transactions,  no  prac- 
tical difficulty  will  be  experienced  in  keeping  as  many  co- 
equal sets  of  sales  accounts  as  the  making  of  the  well-con- 
sidered sales  program  demands. 

Difficult  Problems  in  Preparing  Sales  Budget 

The  chief  difficulties  encountered  in  the  preparation  of 
the  sales  budget  have  been  indicated  in  the  preceding  dis- 
cussion. In  order  that  these  difficulties  may  not  be  disre- 
garded or  minimized,  it  is  deemed  desirable  to  summarize 
them  here.    They  may  be  stated  as  follows: 

1.  Market  fluctuations,  which  make  it  difficult  to  forecast  future 

sales. 

2.  Seasonal  fluctuations,  which  make  it  difficult  to  coordinate  sales 

with  production. 

3.  Inadequate  statistics  withreference  to  past  sales,  which  make  it  diffi- 

cult to  estimate  future  sales. 

4.  Lack  of  standardization,  which  results  in  one  firm  handling  hun- 

dreds of  different  items,  with  the  consequent  difficulty  of  esti- 
mating sales  on  each  item. 

Although  it  is  impossible  to  eliminate  these  difficulties,  it  is 
possible  to  overcome  them  to  a  considerable  extent. 

By  carrying  on  proper  research  work  and  by  collecting 
proper  statistics  it  is  possible,  to  some  extent,  to  estimate 
market  fluctuation.  Of  course,  in  periods  of  violent  read- 
justments following  a  panic  or  a  war  it  is  difficult  to  estimate 


THE  SALES  BUDGET 


85 


the  future  trend  of  the  market.  The  only  resource,  then, 
is  to  make  the  budget  period  as  short  as  possible,  keep  the 
resources  of  the  business  in  a  liquid  condition  so  that  they 
will  be  adaptable  to  sudden  changes,  gather  statistics  at 
frequent  intervals  to  make  possible  a  revision  of  the  budgets, 
and  make  such  changes  as  are  found  necessary  as  quickly  as 
possible. 

Seasonal  fluctuations  may  be  provided  for  in  some  cases 
by  having  seasonal  budgets  so  that  the  seasonal  fluctuations 
can  be  provided  for  at  each  budget  period.  If  it  is  impossi- 
ble to  do  this,  it  is  necessary  to  plan  operations  so  as  to  meet 
these  seasonal  fluctuations  and  to  make  the  budgets  and 
budgetary  reports  correspond.  The  method  of  planning 
production  to  meet  seasonal  sales  will  be  discussed  in  a  later 
chapter  (Chapter  IX). 

Inadequate  statistics  often  present  a  very  serious  diffi- 
culty. The  question  sometimes  arises  as  to  the  advisability 
of  attempting  budgetary  control  before  more  adequate 
statistics  are  obtained  than  are  at  hand.  Although  it  may 
be  impossible  to  make  correct  budgets  on  the  basis  of  infor- 
mation available,  there  is  a  decided  advantage  in  commenc- 
ing the  budgetary  program  and  developing  the  statistical 
records  as  the  work  proceeds.  By  this  means  the  statistics 
required  can  be  clearly  seen  and  the  importance  of  obtaining 
them  can  be  impressed  upon  all  those  responsible  for  their 
preparation.  As  the  program  proceeds  it  is  possible  to 
obtain  statistics  which  will  make  possible  such  revisions  as 
are  found  necessary.  It  is  of  course  understood  that  if 
budgets  are  based  on  inadequate  statistics,  they  must  be 
used  with  much  judgment. 

It  is  usually  necessary,  for  the  purpose  of  coordinating 
sales  and  production,  or  sales  and  purchasing,  to  make  the 
sales  budget  and  the  production  or  purchasing  budget  in 
terms  of  items.    In  a  business  handling  many  thousands  of 


86 


BUDGETARY  CONTROL 


items  this  may  be  very  difficult.  It  has  been  suggested 
previously  that  one  method  of  attacking  this  problem  is  to 
select  those  items  which  represent  the  major  part  of  the 
production  and  budget  them.  By  gradually  increasing  the 
items  selected  for  budgeting,  an  adequate  system  of  budg- 
etary control  can  be  developed. 

No  method  has  ever  been  developed  by  which  to  fore- 
cast with  exactness  the  future  operations  of  a  business.  By 
careful  study,  plans  can  be  made  in  most  businesses  which 
will  correspond  quite  accurately  with  the  results  attained. 
Even  in  those  businesses  where  it  is  possible  to  make  plans 
which  are  only  approximately  correct,  such  plans  are  better 
than  no  plans  at  all. 

It  has  been  the  purpose  of  this  chapter  and  the  chapter 
immediately  preceding,  to  explain  some  of  the  most  impor- 
tant considerations  governing  the  preparation  and  use  of 
the  sales  budget.  In  the  following  chapters  the  preparation 
of  the  budgets  of  the  other  functional  departments  and  the 
coordination  of  the  sales  budget  with  these  will  be  explained 
and  illustrated. 


CHAPTER  VII 


THE  SELLING  EXPENSE  BUDGET 

Relation  of  Selling  Expense  to  Sales 

It  must  be  evident  to  the  reader  that  though  it  is  neces- 
sary to  formulate  a  sales  program,  in  some  such  manner  as 
explained  in  the  two  chapters  immediately  preceding,  such 
a  program  is  lifeless  considered  by  itself.  Making  a  formal 
statement  of  the  volume  of  sales  desired,  or  of  the  class  of 
sales  desired,  does  not  produce  the  sales.  There  must  be  a 
sales  ' '  campaign ' '  as  well  as  a  sales  ' '  program. ' ' 

A  political  party  does  not  win  an  election  by  merely 
nominating  candidates  and  preparing  a  platform.  In  addi- 
tion it  must  conduct  a  campaign  to  convince  the  public  of 
the  merits  of  its  candidates  and  platform.  In  the  same 
manner  a  business  must  conduct  a  sales  campaign  to  con- 
vince the  public  of  the  merit  of  the  product  which  according 
to  its  sales  program  it  is  offering  for  sale. 

A  sales  campaign  may  be  said  to  consist  of  two  mutual 
parts : 

1.  A  knowledge  of  the  sales  desired  and  deemed  possible. 

2.  A  plan  for  securing  the  results  desired  at  the  lowest  possible  cost. 

The  sales  desired  and  deemed  possible  are  determined 
by  the  sales  program  and  are  expressed  in  the  sales  estimate. 
But  this  program  cannot  be  formulated  without  considering 
the  cost  which  it  involves  in  the  way  of  selling  expense. 
There  are  few  firms  which  could  not  increase  their  sales  if 
they  desired  to  incur  the  necessary  expense.  Sales  are  de- 
sired only  when  profits  will  result.  The  probable  profits 
should  be  determined  before  an  attempt  is  made  to  secure 
the  sales.    In  determining  the  probable  profits,  the  selling 

87  • 


88 


BUDGETARY  CONTROL 


cost  which  the  sales  program  will  involve  must  be  given 
careful  consideration.  It  is  obviously  impossible  for  the 
budget  committee  or  the  board  of  directors  to  judge  the  de- 
sirability of  the  contemplated  sales  program  as  presented 
by  the  sales  department  unless  they  know  the  cost  of  this 
program. 

Need  for  Estimate  of  Selling  Expense 

The  selling  expense  estimate  is  needed  for  the  following 
purposes : 

1.  That  the  sales  department  may  be  able  to  judge  the  desirability 

of  its  contemplated  sales  program.  Without  a  knowledge  of 
its  probable  cost  it  is  unable  to  prepare  and  present  for  execu- 
tive consideration  an  acceptable  program. 

2.  That  the  sales  department  may  have  a  basis  for  planning  its  sales 

campaign.  It  must  know  the  funds  which  are  available  before 
it  can  enter  into  contracts  for  services  or  engage  personnel. 

3.  That  the  treasurer  may  know  the  probable  disbursements  re- 

quired by  the  sales  program  and  can  plan  to  obtain  the  funds 
necessary  to  meet  these  disbursements. 

4.  That  the  budget  committee  may  be  able  to  see  the  financial  re- 

quirements of  the  proposed  sales  and  production  programs  at 
the  time  they  are  submitted  to  it  for  consideration.  The  sell- 
ing expense  in  many  cases  constitutes  one  of  the  major  items 
which  appear  on  the  disbursement  side  of  the  financial  budget. 

Importance  of  Sales  Expense  Control 

It  is  highly  important  that  an  effective  control  be  exer- 
cised over  sales  expense  if  the  greatest  amount  of  profit  is  to 
be  derived  from  the  sales  operations.  Unless  that  is  done, 
this  type  of  expense  is  apt  to  increase  unduly. 

The  services  obtained  from  the  expenditures  of  the  sales 
department  are  in  the  main  of  an  intangible  nature  and 
therefore  difficult  to  appraise.  For  instance,  it  is  usually 
difficult  to  determine  accurately  the  benefit  obtained  from 
expenditures  incurred  for  advertising,  and  the  same  is  true 


THE  SELLING  EXPENSE  BUDGET 


89 


to  a  considerable  degree  of  expenditures  for  the  services  of 
salesmen.  There  are  some  direct  results  which  can  be 
traced,  but  in  many  cases  the  major  results  are  so  indirect 
that  they  cannot  be  connected  directly  with  the  ex- 
penditure. 

If  a  purchase  of  materials  is  made  for  the  production 
department,  it  is  possible  to  connect  directly  the  materials 
received  with  the  funds  expended.  It  is  possible  to  judge 
the  w^isdom  of  the  expenditure  by  determining  the  value  of 
the  materials.  But  if  space  for  advertising  is  purchased,  it 
is  usually  not  possible  to  determine  the  number  of  orders 
which  result  from  the  expenditure.  It  is  also  difficult  to 
determine  for  how  long  benefit  may  be  derived  from  the 
advertising.  Orders  may  be  received  as  a  result  of  the 
advertising  some  time  after  the  expenditure  for  it  is  in- 
curred. Again,  a  salesman  may  build  up  good-will  for  his 
company  which  will  result  in  orders  after  his  services  are 
ended.  Because  of  this  indefinite  relation  between  cause 
and  effect,  executives  are  apt  to  think  that  the  sales  expense 
is  necessary  and  should  be  incurred  even  though  direct 
results  cannot  be  seen,  and  therefore  they  may  not  scruti- 
nize closely  the  amount  and  nature  of  this  expense. 

Moreover,  hardly  any  satisfactory  standards  exist  by 
which  to  judge  selling  expense.  It  is  possible  to  determine 
the  amount  of  material  necessary  to  produce  a  certain  arti- 
cle, and  use  this  amount  as  a  standard  to  judge  the  future 
consumption  of  materials  in  the  production  of  that  article. 
But  there  is  no  exact  means  of  determining  the  amount  of 
selling  expense  which  is  necessary  to  secure  a  dollar  of  sales, 
and  it  is  therefore  more  difficult  to  formulate  a  standard  by 
which  to  judge  the  quantity  of  selling  expense. 

Because  of  these  reasons  it  is  especially  necessary  that 
formal  and  exact  control  of  selling  expense  be  exercised. 
This  control  involves  three  steps: 


90 


BUDGETARY  CONTROL 


1.  Determination  of  what  is  included  in  selling  expense  and  the 

setting  up  of  a  proper  classification  thereof. 

2.  Determination  of  standards  by  which  to  judge  the  amount  of 

selling  expense,  and  the  use  of  these  standards  in  the  formula- 
tion of  a  selling  expense  budget. 

3.  Determination  of  methods  of  enforcing  the  standards  set,  and  the 

execution  of  these  methods. 

Definition  of  Selling  Expense 

There  is  a  considerable  difference  of  opinion  among  both 
accountants  and  business  men  as  to  what  should  be  consid- 
ered as  selling  expense.  This  is  probably  due  to  several 
causes. 

There  are  many  items  of  expense  which  contribute  more 
or  less  indirectly  to  the  making  of  sales.  Inasmuch  as  sales 
consummate  the  process  which  results  in  the  securing  of  a 
profit,  it  is  not  difficult  to  reason  that  the  purpose  of  many  of 
the  operations  of  the  business  is  to  secure  sales  and  that  the 
expense  incurred  in  those  operations  should  be  treated  as  a 
selling  expense. 

The  classification  of  expenses  is  discussed  at  some  length 
in  Chapter  XVIII  of  this  book  in  connection  with  the  con- 
sideration of  the  expense  budgets,  and  it  is  not  desired  to 
enter  into  this  subject  here.  Suffice  it  to  say  that  from  the 
viewpoint  of  administrative  control  it  is  desirable  that 
expenses  should  be  classified  so  as  to  indicate  the  responsi- 
bility for  their  incurrence.  Executive  control  can  be  exer- 
cised only  in  terms  of  organization,  and  members  of  an 
organization  can  rightly  be  held  responsible  only  for  that 
over  which  they  exercise  control. 

If  responsibility  is  taken  as  the  controlling  factor  in  an 
expense  classification,  selling  expense  will  include  all  ex- 
penses which  are  under  the  control  of  the  sales  manager  or 
executive  head  of  the  sales  department,  and  in  addition  such 
miscellaneous  items  as  are  directly  connected  with  sales  and 


THE  SELLING  EXPENSE  BUDGET 


91 


the  amount  of  which  is  fixed  or  at  least  beyond  the  direct 
control  of  any  officer. 

An  illustration  of  the  former  case  is  found  in  the  salaries 
of  employees  in  the  sales  department,  who  are  under  the 
direct  control  of  the  sales  manager,  while  an  illustration  of 
the  latter  case  is  found  in  depreciation  on  delivery  equip- 
ment, the  estimated  amount  of  which  is  usually  determined 
by  others  than  the  sales  manager.  The  depreciation  may 
properly  be  treated  as  a  sales  expense,  for  it  is  connected 
directly  with  the  sales  function.  Its  amount,  moreover, 
could  not  be  affected  by  the  action  of  the  sales  manager 
even  if  the  determination  of  it  were  in  his  power,  since  it  is 
assumed  that  the  correct  amount  is  to  be  stated. 

These  illustrations  should  be  sufficient  to  enable  the 
reader  to  determine  the  proper  treatment  of  other  items 
about  which  there  may  be  a  question.  There  are  some  few 
items  the  classitication  of  which  is  dependent  on  a  decision 
as  to  the  purpose  for  which  they  are  incurred,  and  in  many 
instances  there  is  no  unanimity  of  opinion  with  reference  to 
this  purpose.  These  items  will  be  discussed  in  Chapter 
XVIII  on  expense  budgets. 

Classification  of  Selling  Expense 

It  is  customary  to  charge  as  a  part  of  the  cost  of  goods 
sold,  all  expenditures  incurred  in  connection  with  the  product 
up  to  the  time  when  it  is  ready  to  be  offered  for  sale.  This  is 
based  on  the  theory  that  the  sales  department  does  not  have 
jurisdiction  of  the  merchandise  prior  to  this  time  and  is  not 
responsible  for  the  expenditures  incurred  in  connection  with 
it.  The  first  expense  incurred  by  the  sales  department  is  in 
the  securing  of  sales  orders.  This  expense  will  include  the 
expenses  of  the  sales  office  which  directs  the  sales  effort,  the 
salaries  of  salesmen,  and  the  expenses  of  salesmen.  It  may 
also  include  the  cost  of  advertising.    After  the  goods  are 


92 


BUDGETARY  CONTROL 


sold  they  must  be  prepared  for  delivery  to  the  customer — 
which  involves  packing  or  wrapping,  and  finally  they  must 
be  delivered  to  the  customer,  or  to  a  transportation  com- 
pany which  will  effect  the  delivery.  On  the  basis  of  the 
foregoing  discussion  it  is  possible  to  set  up  the  following 
classification  of  sales  expense : 

1.  Sales  office  expense 

2.  Salesmen's  salaries  and  expenses 

3.  Packing  and  shipping 

4.  Advertising 

The  first  three  of  these  items  will  be  discussed  in  the 
present  chapter.  The  control  of  advertising  expense  is 
thought  of  sufficient  importance  to  merit  separate  treatment 
and  its  discussion  will  be  postponed  until  the  next  chapter. 

Sales  Office  Expense 

Sales  must  always  be  subject  to  some  executive  super- 
vision and  this  supervision  results  in  expense.  The  nature 
of  the  supervision  exercised  over  sales  will  depend  upon  the 
size  and  organization  of  each  particular  business.  In  most 
businesses  there  is  a  sales  manager  who  is  the  executive  head 
of  the  sales  department,  and  frequently  he  is  assisted  by  a 
staff.  In  many  cases  there  are  district  offices  each  under 
the  control  of  a  manager  who  is  subordinate  to  the  general 
sales  manager.  Each  district  manager  may  have  a  staff 
of  assistants.  If  a  company  has  a  sufficient  volume  of 
foreign  sales,  it  may  have  an  "export"  sales  office  in  the 
charge  of  a  manager  with  the  appropriate  assistants.  In  a 
company  distributing  its  product  through  branches,  there 
is  a  sales  staff  at  each  branch. 

As  the  sales  organization  grows,  care  must  be  exercised 
to  avoid  incurring  unnecessary  expense.  It  is  but  natural 
that  each  subordinate  office  will  desire  to  enlarge  its  activi- 
ties as  much  as  possible  and  because  of  this  tendency  there 


THE  SELLING  EXPENSE  BUDGET 


93 


may  be  a  duplication  of  work.  There  are  many  activities 
which  can  be  performed  better  by  the  central  sales  office  for 
the  benefit  of  all  the  subordinate  offices  than  by  each  office 
for  itself.  Every  professional  man  who  has  done  work  on 
administrative  control  can  recall  instances  of  duplication  of 
work  in  branch  offices  which  existed  because  it  had  not 
been  called  to  the  attention  of  the  general  officers  responsi- 
ble for  the  control  of  branch  expense. 

The  preparation  of  estimates  of  sales  expense  will  do 
much  to  prevent  incurring  unnecessary  expense  by  units  of 
sales  organization.  These  estimates  will  sei've,  in  the  first 
place,  to  call  the  attention  of  all  the  executives  of  the  com- 
pany to  the  expenses  of  each  unit  and  to  require  them  to 
consider  these  expenses  before  they  are  incurred,  and  in  the 
second  place,  to  pro\'ide  comparison  between  different  units. 
It  should  be  apparent,  if  the  estimate  of  selling  expenses  of 
the  X  unit  calls  for  expenditures  which  are  equal  to  lo  per 
cent  of  estimated  sales,  and  the  estimate  of  the  Y  unit  calls 
for  expenditures  which  are  equal  to  20  per  cent  of  estimated 
sales,  that  the  budget  committee  will  call  for  an  explanation. 
In  fact  the  sales  manager  should  have  asked  for  an  explana- 
tion before  he  transmitted  the  estimates  to  the  executive 
in  charge  of  the  budget  committee,  and  the  latter  should 
call  the  attention  of  the  budget  committee  to  the  fact  and 
to  the  explanation  of  the  sales  manager  which  it  is  assumed 
he  attaches  to  the  estimates  when  he  transmits  them. 

Salesmen's  Salaries  and  Expense 

There  is  usually  little  difficulty  in  deciding  as  to  the  items 
which  should  be  included  under  this  heading  or  as  to  the 
proper  method  of  recording  and  reporting  them.  The  chief 
problem  is  the  controlling  of  such  expenses,  for  they  have 
a  tendency  to  become  unduly  large  unless  an  effective  check 
is  exercised.    One  of  the  chief  sources  of  difficulty  is  the 


94 


BUDGETARY  CONTROL 


determination  of  the  proper  method  of  compensating  the 
salesmen  for  their  services. 

If  definite  salaries  are  paid  salesmen,  it  is  often  difficult 
to  determine  the  equitableness  of  the  amount  paid.  In  an 
attempt  to  lessen  the  difficulty,  salesmen  may  be  paid  in 
whole  or  in  part  on  a  commission  basis.  Some  sales  execu- 
tives think  that  a  salary  plus  a  commission  is  the  most  de- 
sirable method  on  the  theory  that  the  work  of  a  salesman 
cannot  be  judged  entirely  by  the  sales  which  are  directly 
attributable  to  him.  He  may  have  a  certain  advertising 
\'alue  to  the  business  which  is  not  adequately  measured  in 
terms  of  the  sales  orders  which  he  turns  in.  A  salary,  which 
is  not  directly  dependent  on  the  volume  of  sales,  remunerates 
him  for  the  work  which  he  does  towards  building  up  the 
good-will  of  the  firm;  whereas  the  commission  which  he 
receives,  based  on  the  volume  of  sales  secured  or  on  the 
excess  of  sales  over  a  certain  amount,  rewards  efficiency  and 
penalizes  inefficiency.  Those  who  are  exponents  of  the  pay- 
ment of  a  commission  only  contend  that  the  salesman  is 
remunerated  for  the  work  he  does  in  building  up  good-will 
by  the  additional  orders  which  he  will  receive  later  on.  If 
all  orders  received  from  the  salesman's  territory  are  credited 
to  him,  there  is  merit  in  this  contention. 

The  method  to  be  employed  in  remunerating  the  sales- 
men is  a  problem  of  the  sales  department,  but  as  it  has  an 
important  bearing  on  the  preparation  of  the  estimate  of 
selling  expense,  it  is  of  interest  to  the  student  of  budgetary 
control.  It  may  be  added  that,  if  a  proper  control  is  to  be 
exercised  over  these  expenses,  it  is  necessary  to  have  records 
and  reports  which  will  provide  an  analysis  of  sales  and  sell- 
ing expense  showing: 

1.  Whether  tlie  salesman  or  the  territory  is  responsible  for  the  sales. 

2.  Whether  the  sales  which  are  being  made  are  of  the  goods  which 

the  company  most  desires  to  sell.    The  latter,  at  least,  can  be 


1 


THE  SELLING  EXPENSE  BUDGET 


95 


determined  by  obtaining  the  profit  realized  on  sales  made  by 
each  salesman  and  judging  his  efficiency  in  terms  of  profit 
rather  than  by  volume  of  sales. 

The  nature  of  the  reports  used  in  exercising  control  of 
salesmen's  expenses  will  be  discussed  later  in  this  chapter. 

Packing  and  Shipping 

The  amount  of  the  expenses  incurred  in  packing  and 
shipping  merchandise  depends  upon  the  nature  of  the  prod- 
uct sold  and  to  a  considerable  degree  upon  whether  a  firm  is 
doing  a  retail,  wholesale,  or  manufacturing  business.  In  a 
retail  business  the  merchandise  in  most  cases  is  wrapped  by 
the  salesmen,  or  by  clerks  who  are  located  in  each  depart- 
ment for  that  purpose.  It  may  be  delivered  to  the  cus- 
tomer by  the  sales  clerk  at  the  time  of  sale  or  by  the  regular 
delivery  service  of  the  business.  In  a  wholesale  and  manu- 
facturing business  there  is  usually  a  separate  shipping  de- 
partment which  is  responsible  for  the  packing  of  the  mer- 
chandise and  its  delivery  to  the  transportation  company. 
In  a  few  companies  freight  is  paid  on  all  goods  shipped,  in 
which  case  we  have  the  item  of  "  freight  out." 

The  shipping  department  is  not  always  under  the  control 
of  the  sales  department.  In  a  manufacturing  business  it 
may  be  under  the  control  of  the  production  department. 
In  a  department  store  it  may  be  under  the  control  of  the 
operating  superintendent.  If  the  shipping  department  is 
not  under  the  control  of  the  sales  department,  the  latter 
cannot  be  held  responsible  for  the  shipping  expense.  But 
the  estimate  of  shipping  expense  must  be  considered  with 
the  sales  program,  since  it  varies  with  the  volume  of  sales. 

Some  Packing  Cost  a  Manufacturing  Expense 

Not  all  the  expenses  of  packing,  or  at  least  of  placing 
merchandise  in  containers,  are  to  be  treated  as  selling  ex- 


1 


96 


BUDGETARY  CONTROL 


pense.  If  the  packing  is  that  which  goes  directly  on  goods 
and  is  necessary  to  preserve  them  and  to  keep  them  in  a  con- 
dition to  be  sold,  the  charge  is  against  the  cost  of  the  goods. 
Examples  of  such  cases  are  the  jars  which  hold  fruit,  the 
boxes  containing  cigars,  the  paper  wrappers  on  chocolate 
bars,  etc.  Such  containers  or  wrappers  are  an  integral  part 
of  manufacturing  costs  and  should  be  so  treated  in  the 
accounts  and  the  reports.  If  the  wrappers  contain  adver- 
tising matter,  some  part  of  their  cost  may  be  charged  to 
advertising  expense. 

Allocation  of  "Drayage"  Expense 

The  expense  of  packing  goods  for  shipment  may  ordi- 
narily be  treated  as  a  selling  expense,  as  may  also  the  ex- 
pense of  carrying  the  goods  to  transportation  agencies  for 
shipment.  Sometimes  the  same  employees  are  used  in  con- 
nection with  the  unpacking  of  goods  when  received  and  in 
packing  them  for  shipment  after  they  are  sold.  In  such 
cases  the  expenses  incurred  in  connection  with  both  opera- 
tions are  usually  charged  to  one  account  and  then  allocated 
as  between  cost  of  goods  and  selling  expense.  In  many 
cases  the  same  transportation  equipment,  such  as  trucks  or 
horses  and  wagons,  are  used  to  transport  incoming  and  out- 
going goods.  In  such  cases  the  total  expense  is  usually 
charged  to  a  "  drayage  "  account  and  later  allocated  on  some 
equitable  basis,  such  as  the  ratio  of  cost  of  purchases  to 
cost  of  goods  sold.  In  some  cases  the  tonnage  transported 
to  and  from  the  station  may  be  available  and  can  be  used 
as  the  basis  of  allocation. 

Treatment  of  Freight  Out 

There  is  some  difference  of  opinion  as  to  the  treatment  of 
the  expense  incurred  in  shipping  goods  to  customers  if  the 
transportation  charges  are  paid  by  the  vendor.    It  is  some- 


THE  SELLING  EXPENSE  BUDGET 


97 


times  argued  that  such  expenses,  which  are  usually  termed 
"freight  out,"  should  be  deducted  from  gross  sales,  since 
"freight  in"  is  added  to  purchases  in  determining  the  cost 
of  goods  sold.  Such  a  procedure  seems  logical  and  if  trans- 
portation charges  are  paid  by  the  vendor  on  all  the  goods 
sold,  or  on  the  major  part  of  them  there  is  little  objection  to 
this  treatment  since  it  must  be  assumed  that  the  matter  was 
considered  in  setting  the  sales  price  and  a  sufficient  amount 
added  to  cover  the  anticipated  cost  of  shipment.  If,  as  is 
usually  true,  the  vendor  pays  these  charges  only  in  excep- 
tional cases  to  obtain  special  orders,  it  would  seem  more 
proper  to  treat  them  as  selling  expense.  In  these  cases  the 
granting  of  such  concessions  is  under  the  control  of  the  sales 
department  and  allowed  only  w^hen  this  department  thinks 
it  is  advantageous  to  do  so  in  carrying  out  its  sales  program. 
Unless  the  sales  department  is  charged  with  these  expenses, 
it  is  apt  to  be  too  lenient  in  granting  such  concessions,  and 
moreover  the  comparison  of  selling  expense  with  sales, 
period  by  period,  will  not  show  exact  results. 

Analysis  of  Shipping  Expenses 

As  a  matter  of  control  it  is  often  advisable  to  subdivide 
packing  and  shipping  expenses.  A  geographical  analysis 
will  often  prove  useful.  When  uniform  prices  are  quoted 
regardless  of  territory,  an  analysis  of  packing  and  shipping 
expense  on  a  territorial  basis  will  often  show  that  some 
goods  are  being  sold  at  a  very  small  profit  or  even  at  a  loss, 
because  of  the  additional  expenses  incurred  in  connection 
with  their  preparation  for  shipment  and  delivery.  This  is 
apt  to  be  true  particularly  when  a  manufacturer  of  bulky 
articles  has  a  national  market.  One  writer  even  goes  so  far 
as  to  say:  "I  have  never  seen  such  a  division  made  by  a 
national  manufacturer,  selling  from  coast  to  coast,  w^hich  did 
not  show  that  in  some  sections  he  was  selling  merely  to  help 

7 


98 


BUDGETARY  CONTROL 


his  pride  and  not  his  profit;  in  distant  markets,  the  extra 
packing  and  the  high  freight  outward  will  commonly  be 
found  to  absorb  the  entire  normal  profits." 

Use  of  Warehouses  and  Branch  Depots 

Whenever  possible,  sales  should  be  made  f.o.b.  the 
place  of  manufacture.  If  because  of  the  custom  of  the 
trade  the  freight  must  be  paid  by  the  vendor,  then  a  business 
may  find  it  profitable  to  establish  branch  depots  or  ware- 
houses to  which  goods  may  be  shipped  in  bulk  and  then  dis- 
tributed. Many  national  manufacturers  have  such  ware- 
houses. Some  department  stores  in  large  cities  establish 
warehouses  in  different  parts  of  the  city,  from  which  they 
deliver  goods  to  customers.  Where  warehouses  exist  it  is 
necessary  to  give  careful  consideration  to  their  cost  in  pre- 
paring the  expense  estimates. 

Treatment  of  Breakage 

Another  item  of  considerable  importance  in  some  cases 
is  the  loss  arising  as  a  result  of  breakage  or  damage  occurring 
in  the  process  of  shipping.  If  there  is  a  regular,  unavoidable 
breakage  it  can  properly  be  treated  as  sales  expense.  If 
there  is  a  breakage  in  connection  with  one  line  which  is  not 
common  to  all  lines  handled,  it  is  better  to  raise  the  sales 
price  of  this  commodity  sufficiently  to  cover  the  breakage 
and  not  attempt  to  allocate  it  over  all  goods  sold. 

Importance  of  Proper  Handling  of  Packing  and  Shipping  Expenses 

The  matter  of  packing  and  shipping  expense  has  here 
been  gi\'en  considerable  space,  for  it  has  been  the  author's 
experience  that  in  many  cases  definite  responsibility  is  not 
fixed  for  the  administration  of  the  shipping  department  and 
consequently  effective  control  of  shipping  expense  is  not 
exercised.  The  preparation  and  enforcement  of  careful 
estimates  will  aid  in  remedying  this  condition. 


THE  SELLING  EXPENSE  BUDGET 


99 


Method  of  Estimating  Selling  Expense 

One  of  the  most  useful  devices  a  manager  can  have  is 
that  of  expense  standards.  If  he  knows  what  is  current 
practice  in  various  fields  of  expenditure,  he  has  a  sort  of 
norm  against  which  to  measure  his  own  performances  and 
with  which  to  check  his  own  figures  in  the  preparation  of 
budgets.  Such  standards  are  needed  in  controlling  the  oper- 
ations of  all  the  functional  departments,  but  are  particularly 
needed  by  the  sales  manager  because  of  the  nature  of  sales 
expense  and  its  indefinite  relation  to  results. 

Unfortunately,  not  much  has  been  done  towards  de- 
veloping standard  rates  for  selling  expenses.  Some  few 
agencies,  like  the  Bureau  of  Business  Research  of  Harv^ard 
University,  have  gathered  data  w^hich  show  the  prevailing 
rates  in  certain  lines  of  industry.  These  statistics  are  use- 
ful in  enabling  the  executive  to  see  how  his  business  com- 
pares with  others  in  the  matter  of  selling  cost.  Certain 
trade  associations,  moreover,  have  gathered  data  with  refer- 
ence to  the  expenses  of  their  members  and  made  it  available 
for  the  use  of  other  members.  In  the  past  many  firms  have 
hesitated  to  give  their  competitors  data  with  reference  to 
expenses  and  costs.  This  attitude  is  changing  to  a  con- 
siderable degree  and  we  can  expect  that  more  and  more 
there  will  be  available  useful  data  of  this  nature. 

Even  though  data  are  obtainable  w^hich  show  the  selling 
expenses  of  other  firms,  there  is  no  assurance  that  the  rates 
thus  shown  are  desirable.  Each  firm  must  of  necessity 
develop  its  own  rates  and  determine  the  standards  which  are 
applicable  to  its  conditions.  If  periodical  estimates,  based 
on  scientific  research,  are  carefully  made  and  these  estimates 
are  controlled  by  accurate  reports,  a  firm  will  gradually 
develop  standards  which  will  be  very  useful  in  making  plans 
and  judging  results.  Until  such  standards  are  available  it 
must  use  the  best  data  obtainable  in  preparing  its  estimates. 


lOO 


BUDGETARY  CONTROL 


In  preparing  the  estimate  of  selling  expense  it  is  neces- 
sary to  consider  each  class  of  expense  separately.  If  the 
sales  office  expense  has  been  satisfactory  in  the  past,  the 
amount  shown  by  the  past  records  may  be  used  as  a  basis 
for  the  current  estimate,  of  course  considering  separately 
each  item  of  expense.  Consideration  must  be  given  to 
salaries  of  the  sales  manager  and  his  staff,  salaries  of  clerical 
assistants  and  stenographers,  cost  of  supplies,  etc.  In  case 
of  district  or  branch  offices  it  will  be  necessary  to  make  a 
separate  estimate  for  each  item  of  expense  to  be  incurred  in 
these  offices.  It  should  be  evident  that  in  no  case  should 
the  sales  office  expense  be  estimated  on  a  percentage  basis. 
As  sales  increase,  the  ratio  of  "overhead"  expenses  to 
sales  should  decrease.  If  the  sales  office  expenses  are  3 
per  cent  of  sales  when  the  yearly  sales  are  $100,000,  they 
should  be  expected  to  be  something  less  than  3  per  cent 
when  sales  become  $500,000. 

If  salesmen  are  paid  a  commission  they  usually  pay  their 
own  expenses,  and  it  is  consequently  very  easy  to  estimate 
the  cost  of  salesmen's  expenses  and  salaries.  The  rate  of 
commission  is  applied  to  the  estimate  of  sales,  and  the  result 
is  the  estimate  of  salesmen's  salaries  and  expenses.  If  the 
salesmen  are  paid  a  salary  and  the  company  pays  their  ex- 
penses, it  is  necessary  to  consider  each  salesman  individu- 
ally. After  a  list  of  all  salesmen  is  made,  there  will  be 
placed  after  the  name  of  each  his  present  salary  and  the 
normal  amount  of  his  expenses.  This  list  will  be  gone  over 
by  the  sales  manager  and  his  assistants.  If  advances  of 
salesmen's  salaries  are  contemplated,  these  will  be  shown. 
Each  salesman's  expenses  will  be  examined  and  revisions 
made  when  it  is  thought  that  conditions  warrant.  Gradu- 
ally standard  expense  rates  should  be  developed  for  each 
territory  and  the  salesmen's  expenses  based  on  these  stand- 
ards.   If  the  rates  are  fairly  determined,  each  salesman  can 


THE  SELLING  EXPENSE  BUDGET  lOI 

be  required  to  limit  his  expenses  so  that  they  will  not  exceed 
the  standard. 

If  possible,  standards  showing  the  cost  per  unit  for 
packing  and  shipping  should  be  developed.  If  this  is  not 
feasible  because  of  the  variety  of  units  sold,  it  is  then  neces- 
sary to  develop  a  standard  rate  expressed  in  terms  of  a  per- 
centage of  sales.  In  either  case  it  should  be  kept  in  mind 
that  as  the  volume  of  sales  increases,  the  ratio  of  packing 
and  shipping  expense  should  decrease.  Under  normal  con- 
ditions such  a  result  is  to  be  expected  because  there  are  cer- 
tain items  of  overhead  which  will  not  increase  in  proportion 
to  volume  of  goods  handled. 

After  standard  rates  for  packing  and  shipping  expense 
are  developed,  it  is  only  necessary  to  apply  these  rates  to  the 
sales  volume  as  shown  by  the  sales  estimate  to  obtain  the 
amount  of  the  estimated  packing  and  shipping  expense.  If 
there  are  conditions  which  indicate  a  deviation  from  the 
standard  rates,  these  must  be  given  consideration. 

Preparation  of  Selling  Expense  Budget 

The  sales  office  expense  estimate  will  be  prepared  by  the 
staff  of  the  executive  head  of  the  office.  If  there  be  but  one 
sales  office,  the  estimate  will  be  prepared  by  the  staff  of  the 
sales  manager.  If  there  are  branch  or  division  offices,  the 
staff  of  each  office  will  prepare  an  estimate  of  that  office, 
and  after  it  is  approved  by  the  manager  it  will  be  forwarded 
to  the  sales  manager  at  the  general  office. 

The  salesmen's  salaries  and  expense  estimate  should  be 
prepared  by  the  immediate  superior  of  the  salesmen  for 
whom  the  estimate  is  made.  If  there  are  branch  and  divi- 
sion offices,  each  of  these  will  prepare  an  estimate  for  the 
salesmen  belonging  to  that  office,  and  after  it  is  approved  by 
the  manager  it  will  be  forwarded  to  the  sales  manager  at  the 
general  office. 


I02 


BUDGETARY  CONTROL 


The  packing  and  shipping  expense  budget  will  be  pre- 
pared by  the  head  of  the  shipping  department  and  forwarded 
by  him  to  the  sales  manager. 

The  sales  manager  will  make  such  revisions  as  he  thinks 
necessary  in  the  estimates  of  his  subordinates  and  forward 
them  to  the  executive  in  charge  of  the  budget  procedure, 
with  such  recommendations  as  he  may  desire  to  offer.  The 
executi\'e  in  charge  of  the  budget  procedure  will  forward 
these  to  the  budget  committee,  which  will  make  any  re- 
visions which  it  may  think  necessary  and  return  the  esti- 
mate with  its  approval  to  the  executive  in  charge  of  the 
budget  procedure.  The  latter  will  return  them  to  the  sales 
manager,  who  in  turn  will  transmit  to  each  subordinate  his 
budget  as  approved. 

In  form  the  estimate  of  selling  expense  may  be  made  as 
shown  in  Figure  3.  The  purpose  of  each  of  the  columns 
shown  on  this  form  should  be  apparent  to  the  reader. 

In  some  businesses  the  controller  prepares  all  expense 
estimates,  including  those  for  sales  expense.  Although  the 
controller  may  very  properly  be  given  the  authority  to  pre- 
scribe the  form  of  the  estimates  and  the  reports  to  be  used  in 
their  control,  it  is  the  author's  opinion  that  he  should  not 
be  responsible  for  their  preparation.  The  reasons  for  this 
belief  have  been  explained  in  Chapter  III  and  need  not  be 
repeated  here.  As  a  member  of  the  budget  committee  the 
controller  will  have  an  opportunity  to  pass  upon  all  budgets 
submitted  and  should  be  able  to  offer  constructive  criticism 
of  them.  In  some  cases  it  may  be  desirable  to  refer  the 
estimates  to  his  office  for  review  before  they  are  considered 
by  the  budget  committee. 

Control  of  the  Selling  Expense  Budget 

To  exercise  control  of  the  selling  expense  budget,  it  is 
necessary  to  have  a  proper  system  of  reports  which  will  make 


104 


BUDGETARY  CONTROL 


possible  a  proper  check  of  its  operation.  These  reports  may 
be  divided  broadly  into  two  classes: 

1 .  Those  which  are  used  by  the  sales  department  in  the  enforcement 

of  its  budget. 

2.  Those  used  by  the  executives  and  the  budget  committee  to  judge 

how  well  the  sales  department  has  succeeded  in  the  enforce- 
ment of  its  budget. 

The  first  class  of  reports  may  be  well  illustrated  by  those 
required  in  enforcing  the  salesmen's  expense  budget.  The 
reports  used  for  this  purpose  may  in  turn  be  divided  broadly 
into  two  classes: 

(a)  Those  which  are  used  primarily  by  the  general  sales  office. 

(b)  Those  which  are  used  primarily  as  reports  to  salesmen. 

For  the  use  of  the  general  office  it  is  useful  to  make  a 
report  showing  for  each  salesman  the  following  compar- 
isons: 

(a)  Actual  sales  and  estimated  sales 

(b)  Expense  and  sales 

(c)  Actual  expense  and  standard 

(d)  Expense  with  average  of  territory 

If  in  addition  to  the  amounts  these  comparisons  are  ex- 
pressed in  percentages,  the  report  is  much  more  useful.  If 
this  report  shows  wide  variations  between  the  standard 
and  the  actual,  supplementary  reports  should  be  prepared 
explaining  the  variations. 

Reports  may  be  sent  to  the  salesmen  monthly,  or  even 
weekly  if  desired,  showing  a  comparison  between  the  esti- 
mated expense  and  the  actual  and  also  the  profit  earned  by 
their  sales.  In  some  cases  the  gross  profits  by  lines  may  be 
shown  on  these  reports,  so  as  to  indicate  to  the  salesmen  the 
lines  of  merchandise  which  they  should  push. 

For  the  use  of  the  general  executives  and  the  budget 
committee  a  report  may  be  made  in  the  form  of  Figure  4. 


THE  SELLING  EXPENSE  BUDGET 


105 


The  purpose  and  value  of  each  of  the  columns  shown  on 
this  report  should  be  apparent  to  the  reader.  In  case  this 
report  shows  wide  variations  between  the  actual  and  the 
estimated,  supplementary  reports  should  be  submitted 
explaining  the  variations. 


CHAPTER  VIII 


THE  ADVERTISING  BUDGET 

Relation  of  Advertising  to  Selling  Expense 

There  has  long  been  an  argument  among  the  executives 
in  the  marketing  field  as  to  the  relation  of  advertising  and 
selling — principally  as  to  the  proper  relation  between 
the  advertising  manager  and  the  sales  manager.  Some 
have  contended  that  the  advertising  manager  should  be  the 
executive  head  of  an  independent  department,  while  others 
have  insisted  that  he  should  be  subordinate  to  the  sales 
manager.  There  is  no  intention  of  entering  into  this  dis- 
cussion here,  but  it  is  desired  to  emphasize  that  regardless  of 
the  organization  by  which  the  advertising  is  carried  on,  the 
advertising  program  must  be  considered  as  a  part  of  the  sales 
program  as  a  whole  and  the  advertising  expense  must  be 
considered  as  a  part  of  selling  expense. 

It  should  not  be  difficult  for  the  reader  to  see  why  this 
is  true.  The  purpose  of  the  advertising  and  of  the  sales 
force  is  the  same — to  secure  the  maximum  of  profitable  sales 
with  a  minimum  of  cost.  There  are  some  services  in  the 
marketing  of  a  product  which  commonly  can  be  performed 
more  effectively  by  advertising  than  by  the  sales  force,  and 
the  opposite  is  equally  true.  The  advertising  campaign 
must  be  planned  with  reference  to  the  specific  work  which 
it  is  expected  to  perform  in  relation  to  the  other  sales  work 
of  the  company.  Consequently,  neither  the  amount  of  the 
advertising  expense  nor  the  amount  of  the  other  items  of 
selling  expense  can  be  determined  independently.  The 
advertising  budget  must  be  presented  as  a  part  of  the  larger 
selling  expense  budget. 

io6 


THE  ADVERTISING  BUDGET 


The  Advertising  Appropriation 

It  has  long  been  the  practice  of  many  firms  to  make  an 
annual  "appropriation"  for  advertising  expense.  It  may 
seem  strange  that  a  firm  will  make  an  advertising  appro- 
priation but  will  not  make  an  appropriation  for  any  other 
purpose.  We  rarely  hear  of  an  accounting  appropriation, 
a  manufacturing  appropriation,  a  traffic  appropriation,  etc. 
It  may  at  first  be  thought,  since  definite  appropriations  are 
made  for  advertising  expense,  that  this  class  of  expense  is 
more  effectively  and  scientifically  controlled  than  are  the 
expenses  of  the  various  other  departments.  Further  study 
will  lead  one  to  doubt  if  this  be  true.  Rather  one  is  apt  to 
find  that  the  practice  of  establishing  definite  appropriations 
for  advertising  expense  is  based  upon  two  reasons : 

1.  Outside  counsel,  in  the  form  of  advertising  agencies,  have  often 

been  employed  to  direct  the  advertising  and  it  was  necessary 
to  have  a  definite  agreement  with  them  with  reference  to  the 
amount  which  they  were  permitted  to  spend. 

2.  Business  executives  have  not  regarded  advertising  expense  as 

they  have  the  other  expenses  of  the  business,  but  rather  as  an 
additional  expense  which  while  it  might  be  beneficial  was  not 
necessary  for  sur\  i\  al.  As  they  knew  no  definite  way  of  deter- 
mining the  amount  of  the  advertising  expense,  they  guessed  at 
a  lump  sum  which  they  thought  they  could  afford,  and  took  a 
chance  on  obtaining  results  from  it.  In  many  cases  it  was  a 
policy  of  cast  j  our  bread  on  the  waters  and  trust  it  to  return. 

The  professional  advertising  agency  has  rendered  a 
service  by  teaching  business  executives  the  necessity  for 
formulating  an  advertising  program  and  coordinating  this 
program  with  the  sales  program.  It  is  but  natural,  how- 
ever, for  these  specialists  to  be  enthusiasts  for  advertising 
and  it  is  open  to  question  whether  they  have  always  given  as 
much  attention  to  scientific  methods  of  calculating  the 
amount  of  the  advertising  appropriation  as  they  have  to  the 
attempt  to  make  it  as  large  as  possible.    In  many  cases  this 


io8 


BUDGETARY  CONTROL 


proved  a  short-sighted  policy  because  it  produced  a  reaction 
when  the  management  failed  to  see  adequate  returns  for 
the  money  expended.  This  remark  is  not  intended  as  a 
criticism  of  advertising  agencies,  for  many  of  them  have 
rendered  very  useful  service  in  advising  executives  with 
reference  to  the  amount  of  the  advertising  which  they  should 
do,  as  well  as  the  kind  of  advertising  which  would  be  most 
effective.  Their  errors  have  probably  not  been  greater  or 
more  numerous  than  those  of  the  professional  accountant  or 
the  engineer. 

Methods  of  Calculating  Advertising  Cost 

In  recent  years  both  advertising  experts  and  business 
executives  have  come  to  realize,  first,  that  advertising  ex- 
pense is  a  necessary  expense  of  operation,  no  less  than  the 
expense  incurred  in  carrying  on  any  of  the  other  functional 
activities  of  the  business;  second,  that  the  advertising  pro- 
gram is  closely  related  to  the  program  of  the  business  as  a 
whole  and  that  therefore  the  amount  of  the  advertising 
expense  should  be  based  on  contemplated  plans  of  the  busi- 
ness as  a  whole.  As  a  result  considerable  attention  has  been 
given  to  the  proper  method  of  calculating  advertising  ex- 
pense. The  following  methods  are  those  in  most  current  use : 

1 .  The  advertising  expense  of  the  current  period  may  be 
based  on  the  expense  of  the  previous  period,  adding  or  sub- 
tracting a  certain  percentage  depending  on  the  opinion  of 
the  executives  with  reference  to  the  success  of  the  advertis- 
ing program  of  the  preceding  period.  The  general  manager 
may  say  to  the  advertising  manager,  "Last  year  we  spent 
$1 10,000  for  advertising  expenses;  this  year  you  may  spend 
5  per  cent  more."  Such  a  budget  refers  the  advertising 
manager  to  the  expense  accounts  of  the  preceding  year  for 
his  working  program. 

2.  The  advertising  expense  of  the  current  period  may 


THE  ADVERTISING  BUDGET 


109 


be  based  on  the  estimated  sales  of  the  current  period,  deter- 
mining the  amount  by  taking  a  certain  percentage  of  the 
total  volume  of  sales.  For  instance,  the  general  manager 
may  say  to  the  advertising  manager,  "Last  year  we  spent 
5  per  cent  of  sales  for  advertising  expense.  Here  is  our 
sales  expectancy  for  this  year.  We  expect  you  to  secure  the 
sales  at  an  advertising  cost  of  5  per  cent  or  less."  This 
method  is  more  scientific  than  that  suggested  in  (i)  for  it 
requires  the  advertising  manager  to  connect  cause  with 
effect — advertising  expense  with  sales  to  be  secured.  It 
should  be  apparent  that  the  advertising  expense  should  not 
be  based  on  past  sales.  The  advertising  of  the  current 
period  can  have  no  effect  on,  or  no  relation  to,  the  sales  of 
past  periods.  It  is  to  make  possible  the  attainment  of  the 
current  sales  program  that  the  advertising  program  is  in- 
tended, and  the  amount  to  be  expended  under  the  adver- 
tising program  can  only  be  determined  properly  by  con- 
sidering the  current  sales  program. 

3.  The  advertising  expense  of  the  current  period  may  be 
based  on  the  estimated  sales  of  the  current  period,  deter- 
mining the  amount  by  allowing  for  advertising  so  much  per 
unit  of  the  product  which  it  is  planned  to  sell.  For  instance, 
it  may  be  agreed  that  so  many  cents  will  be  spent  for  adver- 
tising for  each  crate,  ton,  dozen — or  other  unit  used  in  the 
estimate — which  is  expected  to  be  sold. 

Readers  interested  in  other  methods  of  calculating  ad- 
vertising cost  may  well  read  articles  by  John  A.  Murphy, 
in  December  9,  1920  and  December  16,  1920  issues  of 
Printers'  Ink. 

Advantages  and  Disadvantages 

Opinion  differs  with  reference  to  the  merits  of  these  dif- 
ferent methods.  No  definite  rule  can  be  laid  down  to 
govern  the  policy  to  be  followed  by  all  businesses.    In  the 


no 


BUDGETARY  CONTROL 


opinion  of  the  author  the  first  method  is  the  one  least  to  be 
desired.  It  is  apt  to  result  in  careless  planning  of  adver- 
tising cost,  since  it  is  so  very  easy  to  add  or  subtract  a  cer- 
tain percentage  of  past  expenses  and  not  to  consider  the 
question  further.  It  is  also  apt  to  result  in  basing  present 
expenses  on  past  expenses  without  giving  proper  considera- 
tion to  the  contemplated  changes  in  the  sales  program.  At 
least  it  fails  to  compel  a  consideration  of  present  plans.>^ 
The  ideal  in  the  designing  of  methods  of  administrative 
control  is  to  secure  those  which  will  compel  coordination 
and  at  the  same  time  promote  progress. 

To  base  the  advertising  appropriation  on  a  percentage  of 
the  volume  of  sales  tends  to  simplicity,  and  in  a  business 
where  the  fluctuation  in  sales  is  not  great  may  give  satis- 
factory results.  This  condition  is  more  apt  to  prevail  in  a 
business  handling  a  staple  and  well-established  line  than  in 
a  business  handling  specialties.  In  a  business  having  many 
and  varied  lines  it  may  be  the  only  feasible  method,  since 
calculation  of  the  unit  cost  of  advertising  for  each  item  of 
goods  sold  may  not  be  practicable.  This  method  has  the 
disadvantage  of  fluctuating  unduly  in  some  cases  because  of 
the  fluctuation  in  the  price  of  purchases  of  materials,  sup- 
plies, and  labor,  and  consequent  fluctuation  of  the  selling 
price./  In  a  period  of  depression  as  many  units  of  commodity 
may  be  sold  as  before  the  depression,  but  at  a  price  which 
will  greatly  decrease  the  total  sales  in  terms  of  dollars  and 
cents.  In  this  case  if  the  advertising  appropriation  is  based 
on  the  sales  volume  expressed  in  terms  of  dollars  and  cents, 
it  will  be  greatly  decreased,  whereas  it  may  be  desirable  to 
keep  up  the  advertising  campaign  in  order  to  maintain  the 
sales  volume  in  spite  of  the  adverse  conditions.  There  is 
something  to  be  said  for  the  possibility  that  if  the  sales  price 
of  the  commodities  sold  has  decreased,  the  cost  of  advertis- 
ing will  decrease  also. 

If  advertising  is  calculated  as  so  much  per  unit  of  product 


I 


THE  ADVERTISING  BUDGET 


III 


sold,  it  tends  to  concentrate  attention  on  the  purpose  for 
which  the  advertising  is  incurred  and  incidentally  to  call 
attention  to  the  unit  cost  and  unit  profit  realized  on  the 
articles  sold.  This  method  is  also  apt  to  cause  the  advertis- 
ing appropriation  to  fluctuate  less,  since  the  units  sold  are 
apt  to  vary  less  than  the  returns  from  sales.  There  may 
be  some  argument  for  having  the  advertising  fluctuate  as  the 
sales  fluctuate.  At  least  there  are  occasions  when  this  is 
true.  There  are  also  other  occasions  where  the  advertising 
may  fluctuate  in  reverse  order  to  the  fluctuations  in  sales. 
A  financially  strong  enterprise  may  increase  its  advertising 
during  a  period  of  depression  in  order  to  reduce  the  decrease 
in  sales  to  a  minimum  and  to  establish  itself  in  the  market 
so  as  to  take  advantage  of  the  contemplated  period  of  pros- 
perity. 

It  would  seem,  regardless  of  whether  the  unit  costs  or 
the  percentage  method  is  used,  that  revisions  will  have  to  be 
made  in  case  of  changing  conditions  which  affect  the  general 
plans  made  at  the  time  the  advertising  appropriation  is 
determined.  The  advertising  appropriation  should  be  re- 
garded as  only  an  estimate  and  subject  to  revision  no  less 
than  the  other  estimates.  Of  course,  in  making  such  re- 
visions outstanding  commitments  must  be  considered. 
^  There  is  reason  to  belie\  e  that  advertising  managers 
have  placed  great  emphasis  on  the  basis  of  determining  the 
amount  of  the  advertising  appropriation,  because  it  has 
been  difficult  to  get  appropriations  approved  and  conse- 
quently it  was  desirable  to  get  a  definite  basis  established 
which  would  give  them  the  maximum  amount  under  all  cir- 
cumstances. 

^  Regardless  of  the  basis  adopted  for  calculating  the  ad- 
vertising appropriation,  each  individual  business  must  make 
constant  study  of  its  advertising  program  with  the  object 
of  revising  it  as  soon  as  the  necessity  is  indicated./- 


112 


BUDGETARY  CONTROL 


Determining  the  Amount  of  the  Advertising  Appropriation 

—  After  the  basis  on  which  the  advertising  appropriation  is 
to  be  calculated  is  decided,  it  is  necessary  to  determine  the 
desired  amount  in  dollars  and  cents.  Theoretically  the 
rate  may  be  determined  without  consideration  of  the  total, 
but  it  is  doubtful  if  this  is  ever  done.  A  firm  may  decide 
that  it  can  well  afford  to  spend  one  cent  per  article  sold  for 
advertising,  but  if  the  total  thus  determined  runs  beyond 
the  amount  necessary  to  pay  for  the  advertising  plans  con- 
templated, the  rate  per  unit  will  be  reduced.  If  a  percent- 
age of  sales  is  used  as  the  basis  the  same  procedure  will  be 
followed.  After  the  total  is  determined  the  rate  will  be 
revised,  if  necessary,  to  make  the  total  somewhat  near  the 
amount  which  the  executives  think  desirable. 

In  determining  the  amount  of  the  appropriation  two 
important  factors  must  be  given  consideration : 

1.  What  is  the  purpose  of  the  advertising — what  is  to  be  accom- 

plished by  it? 

2.  How  is  the  advertising  appropriation  to  be  expended — how  is  the 

purpose  of  the  advertising  to  be  accomplished? 

Purpose  of  Advertising 

If  we  assume  that  a  business  has  previously  done  no 
advertising,  the  selling  price  of  its  commodity  will  be  com- 
posed of  the  following  items:  manufacturing  or  purchase 
cost,  selling  expense,  administrative  expense,  and  profit. 
Expressed  in  the  form  of  an  equation  we  have : 

Cost  of  goods  sold + selling  expensed  administrative  expense 
+profit  =  selling  price 

Obviously,  if  it  is  determined  to  incur  expenditures  for  ad- 
vertising, some  of  the  members  of  this  equation  will  be 
changed.  Either  the  left-hand  members  must  be  decreased, 
or  the  right-hand  member  must  be  increased. 


THE  ADVERTISING  BUDGET 


113 


The  competitive  condition  of  the  market  may  be  such 
that  by  the  advertising  a  sufficient  demand  can  be  created 
for  the  product  to  make  possible  an  increase  in  the  selling 
price.  If  this  be  true,  the  cost  of  the  advertising  may  be 
consumed  by  the  increase  in  selling  price  and  the  other 
members  of  the  equation  left  undisturbed.  This  condition 
is  not  apt  to  exist  in  many  cases  under  present  competitive 
conditions.  In  fact,  only  in  the  case  of  a  monopoly  can 
such  a  result  be  expected  to  be  obtained  permanently. 

If  the  purpose  of  the  advertising  is  to  maintain  the  pres- 
ent volume  of  sales  during  a  period  of  bitter  competition, 
the  expense  may  be  met  out  of  profits.  The  company  may 
desire  to  maintain  its  position  in  the  trade  even  though 
smaller  profits  are  to  be  secured  at  the  present  time.  It 
may  be  thought  that  the  lessened  profits  at  this  time  will  be 
more  than  compensated  for  by  increased  profits  in  the  future. 
Similarly  a  company  may  incur  advertising  in  order  to  ward 
off  hostile  public  opinion  and  to  prevent  undesirable  legis- 
lation. Public  utilities  have  done  considerable  advertising 
of  this  nature  during  past  years.  More  recently  some  of 
the  packing  companies  have  followed  the  same  practice. 
Advertising  of  this  nature  may  well  be  met  out  of  profits 
because  it  is  thought  that  it  will  prevent  lessened  profits  in 
the  future.  Again,  a  firm  may  incur  expenditures  for  adver- 
tising which  will  lessen  current  profits  but  build  up  good- 
will which  in  turn  will  result  in  larger  future  profits. 

In  some  cases  advertising  is  incurred  because  it  is  thought 
that  it  will  increase  the  volume  of  sales  and  thus  result  in  a 
decrease  of  the  cost  of  goods  sold,  the  selling  expense,  or  the 
administrative  expense. 

In  a  manufacturing  business,  an  increase  in  the  volume 
of  sales,  with  the  consequent  increase  in  the  volume  of  pro- 
duction, will  usually  decrease  the  cost  of  production  because 
of  the  decrease  in  the  unit  cost  of  overhead.    It  may  also 

8 


114 


BUDGETARY  CONTROL 


make  possible  a  more  economical  use  of  labor  and  materials.^ 
For  instance,  the  production  may  become  of  sufficient  vol- 
ume to  make  possible  the  use  of  scrap  in  the  production  of  a 
by-product.  t^In  a  mercantile  business  the  increased  volume 
of  sales  may  make  possible  more  economical  purchasing 
with  a  lower  unit  cost  for  goods  purchased,  but  the  savings 
in  this  connection  are  rarely  comparable  with  the  decrease 
in  the  unit  cost  of  goods  manufactured  when  the  volume  of 
production  is  increased.  / 

The  increased  volume  of  sales  may  reduce  the  unit  sell- 
ing cost.  If  the  advertising  enables  each  salesman  to  sell 
more  with  the  same  amount  of  effort  and  expense,  the  unit 
selling  cost  will  be  decreased  accordingly.  In  addition  to 
the  cost  of  salesmen,  the  overhead  expense  incurred  in  main- 
taining the  sales  manager  and  his  staff  is  usually  an  appre- 
ciable amount,  and  an  increase  of  sales  will  not  usually 
cause  this  expense  to  increase  in  proportion. 

Finally,  an  increase  in  volume  of  sales  should  have  a  de- 
sirable result  on  the  administrative  expense.  There  is  every 
reason  why  the  ratio  of  administrative  expense  to  sales 
should  decrease  as  the  volume  of  sales  increases. 

Importance  of  Defining  Purpose  in  Advance 

The  foregoing  discussion  shows  that  there  may  be  sev- 
eral reasons  why  advertising  should  be  undertaken.  /The 
primary  purpose  of  pointing  out  these  various  purposes  is  to 
emphasize  that  the  results  which  it  is  expected  to  obtain  as 
a  result  of  the  advertising  should  be  clearly  in  mind  before 
the  advertising  is  begun.  So  far  as  possible,  data  should  be 
prepared  to  show  the  possible  results  of  the  advertising. 
The  most  difficult  problem  is  that  of  determining  the 
effect  of  the  advertising  on  the  volume  of  sales.  If  this 
can  be  forecast  it  is  usually  possible  to  estimate  the 
approximate  effect  of  the  advertising  on  the  manufactur- 


THE  ADVERTISING  BUDGET 


"5 


ing  cost,  selling  expense,  administrative  expense,  and  net 
profity/ 

*  Unfortunately,  some  firms  make  advertising  appropria- 
tions expecting  to  obtain  a  large  increase  in  volume  of  sales, 
without  stopping  to  determine  whether  the  increase  in  vol- 
ume which  is  anticipated  would  produce  satisfactory  results 
— that  is,  whether  the  savings  resulting  from  the  increase 
will  be  equal  to  the  cost  of  the  advertising./  Only  recently 
a  manufacturing  firm  entered  into  a  large  contract  for  ad- 
vertising and  the  president  showed  the  author  the  estimated 
increase  in  sales  which  he  expected  to  obtain  as  a  result  of 
this  advertising.  A  few  moments'  calculation  showed  that 
if  the  anticipated  volume  of  sales  was  obtained  the  factories 
of  the  company  would  not  be  able  to  produce  goods  to 
satisfy  75  per  cent  of  the  sales  orders.  In  this  case,  regard- 
less of  whether  the  advertising  failed  or  succeeded  so  far 
as  producing  the  contemplated  volume  of  sales,  the  firm 
was  bound  to  lose  as  a  result  of  the  contract.  This  is  but 
another  instance  of  lack  of  coordination,  which  a  proper 
program  of  budgetary  control  would  rectify. 

/ All  of  which  is  to  say  that  advertising  is  merely  a  means 
and  not  an  end  in  itself.  It  is  a  potent  force  in  modern 
management  but  it  produces  satisfactory  results  only  when 
it  is  used  with  judgment  and  is  coordinated  with  the  other 
functional  activities  of  a  business. 

Method  of  Accomplishing  Desired  Purpose 

After  deciding  that  it  is  desirable  to  use  advertising  for 
some  particular  purpose,  it  is  necessary  to  determine  the 
most  effective  way  of  accomplishing  this  purpose.  It  is  not 
enough  to  decide  that  there  are  many  people  who  need  and 
can  afford  the  product  which  you  sell  and  that  you  can 
profitably  spend  a  certain  amount  in  order  to  get  them  to 
purchase  a  certain  volume.    It  is  also  necessary  to  decide 


Ii6 


BUDGETARY  CONTROL 


in  what  way  they  can  be  reached  so  as  to  persuade  them  to 
purchase.  In  other  words,  it  is  necessary  to  decide  upon 
the  medium  of  advertising  to  be  used. 

There  is  a  multiplicity  of  ways  in  which  advertising  may 
be  accomplished.  To  the  layman  the  various  possibilities 
present  a  confusing  complexity.  Because  of  this  very  com- 
plexity it  is  necessary  that  very  careful  consideration  be 
given  to  the  contemplated  program.  Although  the  adver- 
tising department  should  be  given  considerable  freedom  of 
judgment,  this  freedom  should  be  manifested  in  the  main 
before,  instead  of  after,  the  advertising  appropriation  is 
approvedy^  It  does  not  seem  desirable  that  the  department 
be  given  a  lump  sum  without  any  conditions  being  attached 
to  its  use.  In  addition,  it  is  impossible  to  judge  the  amount 
to  be  appropriated  until  the  method  in  which  it  is  to  be  spent 
has  been  determined.  /It  is  only  by  balancing  the  two  fac- 
tors— the  purpose  to  be  accomplished  by  the  advertising  and 
the  method  of  accomplishing  this  purpose — that  it  is  possi- 
ble to  work  out  a  well-balanced  advertising  program. 

Preparation  of  the  Advertising  Budget 

The  preliminary  estimate  of  advertising  expenses  should 
be  prepared  by  the  advertising  manager.  He  should  have 
before  him  the  contemplated  sales  plans  of  the  business,  and 
also  be  familiar  with  the  general  plans  and  policies  of  the 
business  as  a  whole.  If  the  advertising  manager  is  sub- 
ordinate to  the  sales  manager,  he  will  submit  his  estimate 
to  the  latter  for  approval.  In  any  case  he  must  work  in 
cooperation  with  the  sales  manager  in  formulating  the  ad- 
vertising program,  as  the  advertising  program  is  but  one 
part  of  the  sales  program.  The  sales  manager,  or  the  adver- 
tising manager,  depending  on  whether  the  latter  is  subordi- 
nate to  the  former,  will  transmit  the  advertising  program 
to  the  executive  in  charge  of  the  budgetary  procedure,  who 


THE  ADVERTISING  BUDGET 


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Ii8 


BUDGETARY  CONTROL 


will  in  turn  submit  it  to  the  budget  committee  which  will 
make  such  changes  as  it  thinks  necessary  before  approving 
it.  f  As  will  be  show^n  in  the  manual  on  budgetary  pro- 
cedure discussed  in  Chapter  XXIII  jthe  budget  committee 
will  have  befoxe.it  all  the  proposed  budgets  at  one  time  so 
that  it  can  consider  them  as  a  whole.  If  the  committee 
thinks  that  important  changes  in  the  estimate  are  neces- 
sary, it  will  call  the  advertising  manager  before  it  and  give 
him  an  opportunity  to  defend  his  requests. 

After  the  estimate  has  been  approved  by  the  budget 
committee  it  may  be  submitted  to  the  board  of  directors  for 
consideration  and  approval.  When  it  has  been  finally 
approved,  it  then  becomes  the  advertising  budget  for  the 
current  budget  period.  It  w  ill  be  transmitted  by  the  execu- 
tive in  charge  of  the  budgetary  procedure  to  the  advertising 
manager  and  will  constitute  his  working  program  for  the 
period. 

Form  of  the  Advertising  Budget 

The  advertising  estimate  should  be  made  in  such  form 
as  to  show: 

1.  The  lines  of  goods  which  are  to  be  advertised  and  the  amount  to 

be  spent  on  each  of  them. 

2.  The  methods  by  which  the  appropriation  is  to  be  spent  and  the 

amount  to  be  spent  by  each  method. 

The  budget  as  approved  will  show  the  same  information 
as  the  estimate  and  this  makes  possible  the  exercise  of  a 
proper  control  of  advertising  expenditures  (i)  by  purposes 
and  (2)  by  methods  of  expenditure. 

The  executive  in  charge  of  the  budgetary  procedure  is 
responsible  for  seeing  that  supplementary  data  are  prepared 
and  submitted  to  the  budget  committee  with  the  advertising 
budget  which  will  enable  it  to  judge  the  possible  results  of 
the  proposed  advertising  program.    It  is  expected  that  a 


f 


THE  ADVERTISING  BUDGET 


119 


considerable  portion  of  these  data  will  be  prepared  by  the 
advertising  manager  in  support  of  his  request.  He  should 
at  least  present  data  to  show  the  anticipated  effect  of  the 
proposed  program  on  the  volume  of  sales.  The  executi\'e 
in  charge  of  the  budgetary  procedure  will  usually  have  to 
supply  the  data  showing  the  effect  of  the  increased  volume 
of  sales  on  the  manufacturing,  selling,  and  administrative 
cost.  In  preparing  this  he  may  be  assisted  by  the  controller 
and  his  staff. 

Control  of  the  Advertising  Budget 

After  the  advertising  budget  is  adopted  it  is  necessary 
to  take  measures  to  secure  its  enforcement.  The  advertis- 
ing budget  may  be  thought  of  as  a  fixed  amount  of  money 
voted  to  the  advertising  manager  by  the  budget  committee 
or  board  of  directors.  So  it  is — the  advertising  budget  is 
at  once  an  estimate  and  a  limitation  of  authority  to  spend. 
We  have  seen,  however,  that  the  sales  program  is  based  on 
trade  conditions  and  must  be  currently  modified  and 
amended  as  trade  conditions  change.  Similarly,  the  adver- 
tising budget  is  based  on  the  sales  program  to  a  considerable 
degree  and  may  need  to  be  modified  and  amended  when  the 
sales  program  is  changed.  In  order  that  the  relation  between 
the  advertising  program  and  the  sales  program  may  be 
clearly  seen,  it  is  desirable  that  there  be  prepared  at  the  end 
of  each  month  a  report  similar  in  form  to  Figure  5. 

Mr.  W.  A.  McDermid,  in  Administration  for  July,  192 1, 
suggests  the  following  method  of  controlling  the  advertising 
appropriation : 

The  physical  control  of  the  appropriations — the  forms  by  means 
of  which  the  advertising  executive  knows  where  he  stands  day 
by  day — are  relatively  simple.  They  have  been  modified  in 
many  details  for  different  concerns,  but  a  majority  are  based  on 
the  following; 


120 


BUDGETARY  CONTROL 


1.  The  budget  sheet: 

Regardless  of  the  method  by  which  the  appropriation  has 
been  determined,  there  is  laid  out  an  estimate,  roughly 
distributed  month  by  month,  with  subtotals  at  con- 
venient intervals. 

2.  Detail  sheet: 

(a)  For  space.    These  sheets  show,  with  as  much  detail 

as  may  seem  advisable,  the  publications,  dates  of 
insertion,  size  of  space,  and  cost.  The  advertising 
agency  usually  works  this  out  in  compact  form 
both  for  its  guidance  and  approval. 

(b)  For  sundry  costs.    These  sheets  are  usually  more  of  a 

guess  than  the  space  sheets,  but  they  cover  esti- 
mates for  literature,  printing,  engraving,  and  innu- 
merable incidental  costs.  They  should  be  binding 
only  as  to  outside  limits. 

3.  Budget  control  sheet  (see  Figure  6) : 

With  this  before  him  and  his  general  budget  approved, 
the  manager  knows  where  he  stands  all  the  time.  If 
the  appropriation  or  scale  of  expenditure  warrants,  this 
could  be  made  weekly  or  even  daily. 

The  advertising  budget  presents  a  plan  under  which  the 
advertising  manager  may  engage  expert  labor,  make  news- 
paper contracts,  etc.  As  such  contracts  are  made  and  obli- 
gations incurred,  the  advertising  budget  comes  by  degrees 
to  a  stage  where  amendments  are  difficult.  For  example, 
after  a  contract  has  been  made  for  printing  a  shoe  catalogue, 
it  is  of  little  use  to  decide  that  the  money  involved  can  be 
expended  to  better  purpose  in  street-car  advertising.  A 
report  is  needed,  therefore,  which  will  show  the  amounts 
under  each  appropriation  item  still  available  for  contract  or 
for  transfer  to  other  purposes.  Such  a  report  may  be  made 
in  the  form  of  Figure  7. 

A  little  consideration  of  this  report  should  make  apparent 
the  value  and  purpose  of  each  of  the  columnar  headings. 
Columns  (i)  to  (4)  inclusive  show  original  plans  and  the 


THE  ADVERTISING  BUDGET 


121 


122 


BUDGETARY  CONTROL 


i 


THE  ADVERTISING  BUDGET 


123 


changes  made  in  these  plans,  with  the  present  status  of  the 
appropriation  as  a  result  of  these  changes.  Column  (5) 
shows  the  cash  disbursements  which  have  been  made. 
Columns  (6)  and  (7)  show  the  amounts  w^hich  must  yet  be 
financed.  Columns  (8)  to  (10)  inclusive  show  commitments 
which  may  or  may  not  be  subject  to  adjustment.  Column 
(11)  shows  the  amount  available  for  new  contracts  or  for 
transfer  to  other  appropriations  if  this  is  found  advisable. 

The  reports  used  in  exercising  control  of  the  advertising, 
like  all  reports  used  in  budgetary  control,  must  be  made 
promptly  and  accurately  if  they  are  to  be  of  service.  This 
necessitates  that  the  accounting  department  must  render 
reports  immediately  after  the  end  of  the  month  or  other 
period  used  as  a  basis  for  control,  and  it  must  maintain 
accounts  which  will  provide  a  proper  distribution  of  the 
expenditures  incurred  under  the  advertising  budget. 


CHAPTER  IX 


THE  PRODUCTION  BUDGET 

Relation  of  Production  Budget  to  Sales  Budget 

The  sales  program,  as  shown  by  the  sales  budget,  con- 
templates the  delivery  of  certain  commodities  or  services  to 
customers.  To  execute  this  program  it  is  necessary  that 
these  commodities  or  services  be  produced  by  the  firm  which 
offers  them  for  sale  or  that  they  be  purchased  from  other 
firms.  But  these  commodities  or  services  must  not  be 
merely  delivered ;  they  must  be  delivered  at  the  time  and  in 
the  quantity  demanded  by  customers.  This  necessitates 
the  making  of  plans  which  schedule  deliveries  from  the 
factory  or  the  vendors  in  such  a  manner  that  sales  demands 
may  be  met. 

The  execution  of  these  plans  requires  the  preparation  of 
a  production  or  purchasing  budget,  and  the  formulation  of  a 
production  or  purchasing  program.  The  general  principles 
involved  in  the  control  of  the  quantity  of  production  and  of 
purchases  are  very  similar,  but  their  application  in  the  two 
cases  are  sufficiently  different  to  make  a  separate  treatment 
of  the  two  problems  desirable.  It  is  the  purpose  of  the 
present  chapter  to  discuss  the  production  budget.  A  later 
chapter  will  deal  with  the  purchasing  budget. 

Relation  of  Production  Control  to  Production  Policies 

From  the  viewpoint  of  budgetary  control,  manufactur- 
ing industries  may  be  divided  broadly  into  two  general 
classes : 

I .  Those  which  manufacture  a  standard  commodity  or  commodities, 
and  produce  and  place  them  in  stock  in  anticipation  of  sales 
demands. 

124 


THE  PRODUCTION  BUDGET 


125 


2.  Those  which  produce  goods  in  accordance  with  the  customers' 
specifications,  and  hence  cannot  manufacture  for  stock  but 
only  in  response  to  orders. 

In  the  first  case,  it  is  necessary  to  plan  production  so  as  to 
have  available  the  goods  required  when  the  sales  order  is 
received.  In  the  second  case,  it  is  necessary  to  plan  produc- 
tion so  as  to  be  able  to  produce  the  goods  as  quickly  as 
possible  after  the  order  is  secured.  The  preparation  of  a 
production  budget  for  a  manufacturing  industry  producing 
for  stock,  will  be  first  explained.  Such  modifications  as 
are  necessary  for  a  business  producing  on  special  order  will 
then  be  stated. 

Adjusting  Sales  Plans  with  Production  Capacity 

It  has  been  explained  in  the  discussion  of  the  preparation 
of  the  sales  budget  that  the  sales  estimate,  as  submitted  by 
the  sales  units,  should  be  revised  by  the  production  depart- 
ment with  reference  to  production  possibilities.  In  making 
these  revisions  the  production  department  should  not  only 
consider  the  possibility  of  producing  the  volume  called  for 
by  the  sales  estimate,  but  also  the  possibility  of  producing 
this  volume  at  an  economical  cost.  The  sales  estimate  may 
call  for  the  production  of  some  items  in  such  small  quantities 
that  they  cannot  be  produced  economically,  or  it  may  call 
for  such  a  volume  of  production  of  some  items  that  it  would 
be  necessary  to  incur  so  great  an  amount  of  extra  expense  to 
produce  the  amount  required  that  it  would  be  unprofitable 
to  do  so. 

It  may  also  be  that  the  sales  estimate  is  such  that  it  does 
not  provide  for  a  well-balanced  production  program.  It 
may  call  for  so  many  of  some  items  and  so  few  of  others  that 
the  result  would  be  the  overloading  of  some  departments  or 
some  machines,  and  a  lack  of  work  for  other  departments  or 
other  machines.    The  production  department  should  have 


126 


BUDGETARY  CONTROL 


available  data  on  production  capacity  which  will  indicate  all 
this,  so  that  it  can  suggest  the  necessary  revisions  in  the 
sales  estimate. 

To  be  able  to  make  these  revisions  it  is  necessary  for  the 
production  department  to  have  data  of  two  kinds : 

1.  It  must  have  an  analysis  of  each  of  the  products  offered  for  sale 

which  shows  the  manufacturing  operations  necessary  in  its 
production. 

2.  It  must  have  a  record  of  each  of  the  machines  operated  by  the 

company,  showing  the  operations  the  machine  performs  and 
the  number  of  operations  it  can  perform  in  a  specified  time. 

If  these  data  are  available  it  is  possible  to  determine  the 
volume  of  the  operations  required  to  produce  the  goods 
called  for  by  the  sales  estimate  and  to  balance  this  against 
the  machine  capacity  of  the  plant.  Three  situations  may 
arise : 

1.  The  sales  budget  may  approximately  equal  the  production 

capacity.    This  is  the  desirable  result. 

2.  The  sales  budget  may  exceed  the  production  capacity,  in  which 

case  one  of  three  things  must  be  done: 

(a)  The  sales  budget  may  be  reduced. 

(b)  Additional  equipment  may  be  secured. 

(c)  Some  goods  may  be  purchased  from  outside  sources. 

3.  The  sales  budget  may  be  less  than  the  production  capacity,  in 

which  case  it  may  be  desirable  to  attempt  to  increase  the  sales 
program  so  as  to  provide  for  a  more  desirable  production  pro- 
gram. In  some  cases  this  may  be  impossible.  Under  these 
conditions  some  machinery  may  be  left  idle  until  an  increase  in 
sales  can  be  secured.  If  it  is  evident  that  the  decrease  in  sales 
is  permanent,  the  production  capacity  may  be  reduced  by  the 
sale  of  the  unnecessary  equipment. 

It  is  not  an  easy  matter  to  coordinate  sales  possibilities 
with  production  capacity.  In  fact  it  is  one  of  the  most 
difficult  of  administrative  problems.  The  need  for  this 
coordination  is  so  great,  however,  that  it  is  worth  while  to 


THE  PRODUCTION  BUDGET 


127 


Spend  any  amount  of  effort  in  order  to  secure  it.  The  first 
step  in  the  solution  of  the  problem  is  the  preparation  of  data 
to  show  what  the  possible  sales  are  and  what  the  available 
production  capacity  is. 

In  so  far  as  possible,  a  manufacturing  business  should 
select  its  machinery  and  equipment  so  that  it  will  be  well- 
balanced  and  flexible,  as  this  makes  it  possible  to  adapt 
production  to  variations  in  sales  demands.  There  is  a 
limit,  however,  to  the  extent  to  which  machinery  can  be 
adapted  to  different  uses,  and  there  should  be  an  attempt  to 
harmonize  the  sales  program  with  the  factory  possibilities. 
Often  it  is  possible  to  shift  the  emphasis  of  the  sales  program 
by  means  of  extra  efforts  on  the  part  of  the  salesmen  and  by 
the  nature  of  the  advertising,  and  to  increase  the  sales  of  the 
items  which  the  factory  is  best  adapted  to  produce. 

Determination  of  Production  Requirements 

If  the  production  department  makes  a  careful  revision 
of  the  sales  estimate,  and  if  its  recommendations  are  given 
proper  consideration,  the  sales  budget  will  represent  factory 
requirements  which  are  both  possible  and  profitable.  After 
the  sales  budget  is  adopted,  the  production  department  has 
an  estimate  of  the  requirements  of  the  sales  units  during  the 
next  budget  period.  Presumably  these  requirements  state 
the  number  of  each  item  of  goods  manufactured  by  the 
company  which  must  be  provided  to  the  selling  units  during 
the  period.  In  order  to  translate  these  requirements  of  the 
sales  units  into  an  estimate  of  production  for  the  period,  it 
is  necessary  for  the  production  department  to  take  into 
consideration  the  inventory  of  finished  goods  at  the  begin- 
ning of  the  period  and  the  estimated  inventory  of  finished 
goods  at  the  end  of  the  period. 

To  illustrate:  The  ten  sales  units  of  the  X  Manufactur- 
ing Company  estimate  their  requirements  from  the  factory 


128 


BUDGETARY  CONTROL 


for  article  Y  for  the  next  budget  period  to  be  120.  The 
records  of  the  factory  show  that  the  inventory  of  article  Y 
at  the  beginning  of  the  budget  period  is  30,  and  it  is  esti- 
mated that  an  inventory  of  20  at  the  end  of  the  period  will 
be  sufficient.  The  estimate  of  production  on  article  Y  for 
the  period  will  be  120+20  —  30=110.  Each  item  on  the 
sales  budget  must  be  considered  in  the  same  manner  in  order 
to  determine  the  estimate  of  production  for  the  period. 

Relation  of  Inventory  of  Finished  Goods  to  Estimate  of  Produc- 
tion 

But  the  problem  of  the  production  department  is  not 
merely  to  produce  the  quantity  of  goods  that  are  to  be  sold 
during  the  budget  period.  It  must  do  more  than  that;  it 
must  produce  the  goods  in  anticipation  of  sales  orders  and 
place  them  in  the  finished  storeroom  so  that  customers  may 
be  served  promptly  and  according  to  the  delivery  dates 
given  in  the  sales  contracts.  An  easy  solution  of  this  prob- 
lem would  be  to  manufacture  before  the  beginning  of  the 
budget  period,  or  shortly  thereafter,  all  the  goods  that  are 
to  be  sold  during  the  period.  For  example,  if  the  owners  or 
officers  of  an  automobile  factory  estimate  that  they  will  sell 
200  automobiles  during  the  budget  period,  the  production 
manager  may  manufacture  and  place  in  the  storeroom  these 
200  automobiles  on  or  before  the  first  day  of  the  period. 
Such  a  procedure  is  clearly  impracticable  except  in  rare 
cases. 

In  the  first  place,  the  production  manager  must  distrib- 
ute his  manufacturing  processes  throughout  the  year,  so  far 
as  this  is  practicable,  in  order  that  he  may  make  the  fullest 
possible  use  of  floor  space  in  his  factory  and  of  machinery 
and  equipment,  and,  more  important  still,  in  order  that  he 
may  give  employment  continuously  through  the  year  to  all 
of  his  skilled  employees  and  to  as  many  of  his  unskilled  em- 


THE  PRODUCTION  BUDGET 


129 


ployees  as  possible.  From  every  standpoint  it  is  clearly 
undesirable  for  the  production  manager  to  make  up  all  the 
product  in  advance  of  the  selling  period  and  then  shut  down 
the  factory  for  several  weeks  or  months.  To  a  less  degree, 
it  is  undesirable  for  the  production  manager  to  operate  his 
factory  at  100  per  cent  capacity  for  eight  months  of  the  year 
and  at  50  per  cent  capacity  during  the  other  four  months. 
Under  any  system  of  finished  stock  control,  there  will  be 
varying  production  requirements  at  different  seasons  of  the 
year,  but  two  very  important  considerations  from  the  stand- 
point of  the  factory  superintendent  are:  (a)  that  a  sufficient 
amount  of  finished  stock  shall  be  on  hand  to  meet  sales 
orders,  and  (b)  that  this  stock  shall  be  constantly  replen- 
ished from  goods  in  process  in  the  factory. 

In  the  second  place,  it  is  clearly  undesirable  to  manu- 
facture goods  in  complete  anticipation  of  the  demands  of 
the  selling  period,  because  of  the  large  amount  of  capital 
required.  If  automobiles  to  the  value  of  $500,000  are  ex- 
pected to  be  sold  during  the  year  1922,  it  is  clearly  undesir- 
able to  ha\e  all  these  automobiles  on  the  floor  of  the  ware- 
room  on  December  31,  1 92 1 .  The  $500,000  invested  should 
be  at  productive  use,  and  it  is  an  economic  loss  to  maintain 
stocks  of  finished  goods  on  hand  for  any  longer  period  than 
is  absolutely  necessary  to  make  reasonably  sure  of  prompt 
shipment  to  customers. 

From  the  foregoing  discussion  it  can  be  seen  that  it  is  not 
enough  to  know  the  total  amount  to  be  produced  during  the 
budget  period.  It  is  necessary,  in  addition,  to  schedule 
production  so  that  a  sufficient  amount  of  goods  will  be  on 
hand  at  all  times  to  meet  sales  demands  and  yet  prevent  an 
excess  of  inventory  and  the  consequent  loss  on  the  capital 
invested.  In  order  to  accomplish  this,  it  is  necessary  to  set 
up  a  schedule  for  the  inventory  of  finished  goods  and  to  set 
up  a  schedule  of  production  which  will  maintain  the  in- 
9 


I30 


BUDGETARY  CONTROL 


ventory  schedule.  The  ideal  schedule  would  be  one  which 
delivered  to  stock  each  day  the  exact  amount  of  goods  which 
would  be  sold  during  the  day.  If  such  a  schedule  couM  be 
maintained  during  300  sales  days  of  the  year,  the  stock  of 
goods  in  the  finished  goods  storeroom  would  be  turned  over 
300  times.  In  such  an  ideal  situation,  $40,000  of  stock 
might  be  delivered  into  the  stockroom  daily  and  be  sold 
300  times.  As  will  be  seen  readily,  such  a  $40,000  stock  so 
operated  would  satisfy  the  requirements  of  a  sales  volume 
of  $12,000,000. 

Unfortunately  the  daily  sales  are  not  uniform  in  amount 
and  production  is  not  sufficiently  standardized  to  insure 
a  uniform  daily  delivery  to  stock;  consequently,  for  both 
these  reasons  it  is  impossible  to  deliver  into  stock  each  day 
the  same  amount  of  goods  that  is  to  be  shipped  to  customers 
on  that  day.  It  is,  therefore,  necessary  to  carry  an  inven- 
tory to  provide  for  the  lack  of  coordination  of  sales  and  pro- 
duction. A  most  important  problem  of  production  con- 
trol is  to  determine  the  desirable  amount  for  this  inventory 
and  to  plan  production  so  as  to  maintain  it  at  this  amount. 

The  inventory  of  finished  goods  is  not  a  fixed  or  uniform 
amount.  Since  its  purpose  is  to  take  up  the  slack  between 
production  and  sales,  this  should  be  evident.  It  is  a  con- 
stantly varying  amount.  Because  of  its  constant  fluctua- 
tions, it  is  necessary  that  an  effective  control  be  exercised 
over  it.    This  control  involves  the  following: 

1.  The  establishment  of  maximum  and  minimum  limits,  to  serve  as 

a  check  on  its  size. 

2.  The  establishment  of  adequate  records  and  an  adequate  proce- 

dure to  enforce  these  limits. 

"Maximum"  and  ''Minimum"  Limits  as  a  Basis  of  Inventory 
Control 

"Maximum"  and  "minimum"  limits  should  be  estab- 
lished for  each  item  of  finished  goods  carried  in  stock.  The 


THE  PRODUCTION  BUDGET 


131 


"maximum"  states  the  amount  above  which  the  inventory 
should  never  be  permitted  to  go  except  by  special  permission 
of  the  executive  officers ;  the  ' '  minimum ' '  states  the  amount 
to  which  the  stock  of  any  item  can  be  depleted  before  the 
placing  of  a  production  order  to  replenish  it.  When  the 
sales  orders  reduce  the  stock  to  or  below  the  minimum,  a 
production  order  should  be  issued  for  the  amount  decided 
upon  as  the  "quantity  to  order." 

The  production  department  should  establish  minima, 
quantities  to  order,  and  maxima,  in  accordance  with  the 
following  principles : 

1.  There  should  be  at  all  times  sufficient  stock  on  hand  to  satisfy 

customers'  demands,  if  such  demands  are  consistent  with  the 
capacity  of  the  factory. 

2.  There  should  not  be  larger  stocks  on  hand  than  can  be  turned 

over  in  a  period  necessary  for  the  production  of  a  similar  quan- 
tity, unless  such  quantities  do  not  constitute  an  economical 
run. 

3.  Goods  should  be  produced  in  quantities  large  enough  to  insure 

economical  production. 

The  following  factors  should  be  considered  in  establish- 
ing minima,  quantities  to  order,  and  maxima : 

1.  Production  period 

2.  Probable  sales 

3.  Margin  of  safety 

4.  Economical  run 

Production  Period 

The  production  period  is  the  time  required  from  the 
placing  of  an  order  until  the  finished  goods  are  delivered  to 
the  storehouse.  Obviously  this  period  cannot  be  established 
exactly  and  will  vary  according  to  the  quantity  ordered, 
since  it  will  take  longer  to  produce  10,000  items  than  to 
produce  1,000  items.  Sufficient  data  can  be  collected, 
however,  to  estimate  the  approximate  length  of  this  period 


132 


BUDGETARY  CONTROL 


for  different  quantities  of  production.  In  the  absence  of 
better  statistics  it  may  be  necessary  to  use  the  average 
production  period,  as  shown  by  the  records  of  past  produc- 
tion. Obviously  investigation  and  study  should  be  made 
to  determine  the  desirability  of  this  average  period  and 
changes  made  in  the  light  of  this  investigation. 

Probable  Sales 

The  probable  sales  for  the  budget  period  are  stated  in 
the  sales  estimate.  By  using  the  ratio  of  the  average  pro- 
duction period  to  the  budget  period,  the  probable  sales  for 
the  production  period  can  be  determined.  To  illustrate, 
if  the  production  period  is  thirty  days  and  the  quarterly 
sales  estimate  is  600  units  of  item  Y,  the  probable  sales  for 
the  production  period  are  200. 

Margin  of  Safety 

Neither  probable  sales  nor  the  length  of  the  production 
period  can  be  forecast  with  exactness.  Consequently,  if 
the  minimum  is  established  as  the  probable  sales  for  the 
production  period  and  a  production  order  is  issued  when  the 
minimum  is  reached,  it  will  be  only  in  rare  cases  that  stocks 
on  hand  will  be  exactly  depleted  when  the  newly  manu- 
factured product  arrives  at  the  storehouse.  Probable  sales 
may  be  oversold;  strikes,  breakdowns,  and  delays  in  de- 
liveries of  raw  material  may  interfere  with  the  normal 
course  of  production.  It  becomes  necessary,  therefore,  to 
have  a  quantity  of  finished  goods  on  hand  in  excess  of  the 
probable  sales  for  the  production  period  at  the  time  the  pro- 
duction order  is  issued.  This  excess  may  be  termed  the 
"margin  of  safety." 

The  margin  of  safety  is  usually  estimated  at  from  10  to 
25  per  cent  of  the  probable  sales  for  the  production  period. 
Its  amount  will  vary  in  different  businesses  and  may  well 


THE  PRODUCTION  BUDGET 


133 


vary  with  reference  to  different  items  in  the  same  business. 
Whenever  the  inventory  of  any  item  falls  below  the  margin 
of  safety  the  production  manager  should  be  notified.  He 
may  find  it  necessary  to  resort  to  emergency  measures  to 
replenish  the  stock  if  there  are  indications  that  the  margin 
of  safety  is  not  sufficient  to  supply  the  sales  demand  until 
additional  stock  is  received  from  the  factory.  If  a  well- 
organized  planning  system  is  maintained,  it  will  be  possible 
to  determine  the  length  of  time  before  additional  goods  will 
be  received.  It  is,  of  course,  not  necessary  to  resort  to 
emergency  production  or  purchasing  each  time  the  inven- 
tory falls  below  the  margin  of  safety.  In  fact,  its  purpose  is 
to  provide  for  just  such  cases.  It  is  desirable,  however,  to 
call  the  attention  of  the  production  executive  to  the  fact 
that  the  margin  of  safety  is  reached  so  that  he  may  take  ac- 
tion if  he  deems  it  necessary.  Used  in  this  manner,  the 
limit  set  by  the  margin  of  safety  serves  as  a  danger  signal. 

Economical  Run 

In  determining  the  "economical  run"  it  is  necessary  to 
determine  the  time  necessary  for  "tearing  down"  and 
"  setting  up  "  the  machines  used  in  making  each  item.  This 
involves  the  collection  of  data  showing  machine  operations, 
so  that  the  machines  required  in  the  production  of  each  item 
can  be  determined  and  the  cost  involved  in  "setting  up" 
these  machines  for  the  production  of  each  item  estimated. 
It  is  impossible  to  set  an  arbitrary  standard  for,  or  to  de- 
termine with  exactness  just  what  constitutes,  an  economical 
run,  but  certain  limits  can  be  set  up.  The  problem  of 
determining  what  constitutes  an  economical  run  usually 
arises  only  in  connection  with  slow-moving  items,  of  which 
only  a  limited  amount  is  sold  during  the  production  period. 
In  the  consideration  of  such  items,  it  is  necessary  to  offset 
the  high  unit  cost  of  producing  them  in  small  quantities 


134 


BUDGETARY  CONTROL 


against  the  capital  cost  of  carrying  a  large  inventory.  Con- 
siderable judgment  must  be  used  and  considerable  research 
should  be  carried  on  in  determining  the  most  profitable  pro- 
cedure. Such  a  study  may  often  result  in  the  elimination  of 
some  items  from  the  manufacturing  program.  It  may  be 
determined  that  it  is  cheaper  to  purchase  the  small  amount 
needed  from  other  manufacturers,  or  it  may  be  decided  to 
eliminate  them  from  the  sales  program.  Whether  they  can 
be  eliminated  from  the  sales  program  will  depend,  of  course, 
upon  the  effect  of  this  elimination  on  the  sale  of  other  items. 

Method  of  Calculating  "Maximum"  and  "Minimum" 

As  previously  explained,  the  probable  sales  for  the  pro- 
duction period  are  the  quantity  expected  to  be  turned  over 
during  that  period.  The  margin  of  safety  is  the  amount 
which  it  is  thought  necessary  to  carry  in  addition  to  insure 
against  contingencies.  Therefore,  the  quantity  to  which 
stocks  can  be  depleted  before  a  production  order  is  started 
is  the  sum  of  the  probable  sales  for  the  production  period 
and  the  margin  of  safety.  This  is  the  minimum.  When- 
ever stocks  are  depleted  to  this  quantity,  a  production  order 
is  started.  The  product  specified  on  the  order  goes  through 
the  production  process  and  arrives  at  the  storeroom,  ideally, 
when  stocks  have  been  reduced  to  the  margin  of  safety. 

Quantities  to  order  must  be  established  under  two  sets 
of  conditions.  Each  condition  of  facts  will  influence  the 
quantity  which  is  to  be  ordered.  These  conditions  and  the 
procedure  in  each  case  are  as  follows : 

1.  Where  the  probable  sales  for  the  production  period  is  less  than 

the  amount  of  the  economical  run,  the  latter  amount  becomes 
the  quantity  to  order. 

2.  Where  the  amount  of  probable  sales  for  the  production  period  is 

equal  to  or  greater  than  the  amount  of  the  economical  run,  the 
fonner  amount  becomes  the  quantity  to  order. 


THE  PRODUCTION  BUDGET 


135 


The  maximum  is  the  sum  of  the  minimum  and  the 
quantity  to  order.  It  is  the  danger  mark  which  must  not  be 
exceeded.  In  the  case  of  many  products  the  maxima  will 
never  be  reached,  since,  during  the  time  that  goods  are  being 
produced,  stocks  on  hand  are  being  depleted  by  shipments 
on  orders.  From  the  foregoing  it  can  be  seen  that  the 
maximum  is  estabhshed  by  adding  to  the  minimum  the 
"normal"  quantity  to  order,  that  is,  the  quantity  to  order 
in  case  the  production  order  is  issued  when  the  stock  on 
hand  exactly  equals  the  minimum.  As  a  matter  of  practice, 
the  production  order  is  usually  issued  when  the  inventory  is 
slightly  below  the  minimum,  since  the  sales  order  which  re- 
duces the  inventory  to  the  minimum  will  probably  reduce  it 
somewhat  below.  In  some  cases  it  is  better  for  the  produc- 
tion order  to  be  made  out  for  the  difference  between  the 
actual  inventory  and  the  maximum,  than  to  be  made  out 
for  the  difference  between  the  minimum  and  the  maximum. 
The  reasons  for  this  are  apparent. 

Finished  Goods  Records 

To  enforce  the  requirements  with  reference  to  maxima, 
quantity  to  order,  and  minima,  as  outlined  in  the  preceding 
paragraphs,  it  is  necessary  to  maintain  a  finished  goods 
record  which  provides  a  perpetual  inventory  of  finished 
goods.  The  maximum,  quantity  to  order,  and  minimum, 
as  established  for  each  item  of  finished  stock,  will  be  shown 
on  the  finished  goods  record.  Usually  this  record  is  kept 
in  what  is  termed  a  "balance  of  stores"  form  which  is  espe- 
cially adapted  for  exercising  effective  inventory  control. 
The  form  of  a  balance  of  stores  record  is  illustrated  in 
Chapter  X. 

It  should  be  understood  that  it  is  not  intended  to  lay 
down  an  arbitrary  procedure  in  the  foregoing  discussion. 
The  method  of  establishing  maxima,  minima,  and  quanti- 


136 


BUDGETARY  CONTROL 


ties  to  order  has  been  discussed  somewhat  in  detail,  and  a 
definite  procedure  has  been  explained  in  order  to  indicate 
the  problem  involved  in  enforcing  a  production  budget 
based  on  a  sales  budget.  Although  the  procedure  outlined 
is  typical  of  that  which  must  be  employed  by  any  factory 
which  produces  for  stock  and  which  attempts  to  execute  a 
production  program  in  a  systematic  manner,  variations  of 
considerable  consequence  will  of  necessity  be  made  in 
adapting  this  procedure  to  particular  cases. 

Relation  of  Production  Planning  to  the  Production  Budget 

A  balance  of  stores  record  properly  operated  results  in 
the  issuance  of  production  orders  with  sufficient  frequency  to 
provide  for  the  replenishment  of  stock  in  accordance  with 
the  finished  goods  schedule  prepared  under  the  production 
program.  But  in  order  that  these  production  orders  may 
result  in  deliveries  according  to  schedule,  it  is  necessary  that 
there  exist  an  effective  production  control.  Such  control 
usually  necessitates  the  establishment  of  a  systematic 
organization  to  carry  on  production  planning.  This 
organization  is  usually  called  the  planning  department.  It 
is  not  possible  or  desirable  to  discuss  here  the  organization 
and  operation  of  a  planning  department.  This  is  a  matter 
of  production  management.  It  is  important  to  keep  in 
mind,  however,  that  the  planning  function  must  be  per- 
formed either  by  a  separate  organized  department  or  by 
different  individuals  in  different  departments,  if  the  produc- 
tion budget  is  to  be  translated  into  an  effective  production 
program. 

Relation  of  Production  Costs  to  the  Production  Budget 

The  preceding  discussion  has  treated  primarily  of  the 
problem  of  producing  the  volume  of  finished  goods  called 
for  by  the  production  budget.    What  constitutes  finished 


THE  PRODUCTION  BUDGET 


137 


stock  in  a  particular  business  depends  upon  the  character 
of  the  product  offered  for  sale  to  customers  of  the  business. 
The  finished  stock  of  the  X  Foundry  Company  becomes  the 
raw  material  of  the  Modem  School  Desk  Manufacturing 
Company.  The  lumber,  as  it  comes  from  the  mill  of  a 
lumber  company,  may  be  finished  stock  if  the  lumber  com- 
pany offers  the  green  lumber  for  sale  to  its  customers.  Or 
sawed  lumber  may  be  seasoned  and  planed,  and  so  made 
into  finished  lumber  of  the  higher  grades.  Materials  are 
either  (a)  raw  materials ;  (b)  goods  in  process ;  or  (c)  finished 
stock,  depending  upon  the  stage  of  their  utility  to  the 
customers  of  the  selling  company. 

For  census  purposes  we  may  classify  certain  materials 
as  "raw  materials,"  or  basic  materials,  but  that  classification 
does  not  hold  in  the  reports  of  any  particular  company 
where  the  only  test  must  be  that  finished  stock  is  stock  in 
the  form  demanded  by  customers. 

The  finished  stock  of  a  company  may  be  produced  in  the 
factory  of  the  company  from  raw  materials ;  or  it  may  be  as- 
sembled and  altered  from  parts  in  the  alteration  room  of  the 
company;  or  it  may  be  purchased  as  finished  stock.  The 
present  discussion  is  confined  to  a  consideration  of  the 
finished  stock  of  a  manufacturing  company  which  is 
produced  in  its  factory.  All  such  stock  is  produced  by  the 
employment  of  labor  and  equipment  in  the  performance  of 
certain  operations  upon  raw  materials  by  which  they  are 
transformed  into  the  finished  product. 

Although  it  is  not  the  function  of  the  budgetary  pro- 
gram to  prescribe  the  method  by  which  production  is 
carried  on,  since  this  is  the  province  of  the  planning 
department,  it  is  necessary  for  effective  production  con- 
trol that  a  budget  be  prepared  for  each  of  the  elements 
of  production  cost — materials,  labor,  and  overhead — to 
the  end: 


138 


BUDGETARY  CONTROL 


1.  That  the  necessary  amount  of  materials  and  labor  will  be  avail- 

able and  excess  amounts  will  be  prevented. 

2.  That  the  cost  of  materials,  labor,  and  overhead  shall  be  under 

effective  control. 

3.  That  the  cost  of  financing  the  production  program  may  be 

determined  for  the  purpose  of  the  financial  budget. 

The  preparation  of  the  materials,  labor,  and  manufactur- 
ing expense  budgets  will  be  discussed  in  the  chapters  im- 
mediately following  the  present  one. 

Control  of  Production  on  Special  Orders 

Many  manufacturing  businesses  receive  some  special 
orders  for  goods  which  they  do  not  carry  in  stock  but  which 
they  produce  in  response  to  the  requests  of  customers. 
There  are  a  few  businesses  which  produce  all  their  goods  in 
accordance  with  the  customers'  specifications,  and  therefore 
produce  only  on  special  orders.  A  foundry  is  a  good  illus- 
tration of  the  latter  class.  In  either  case,  the  problem  of 
production  control  is  not  greatly  different  from  that  of  the 
business  which  manufactures  for  stock  on  standard  orders. 

In  the  case  of  a  business  which  manufactures  on  both 
standard  and  special  orders,  it  is  necessary  to  determine 
what  proportion  of  the  orders  received  will  be  special  orders. 
In  making  the  sales  estimate  the  special  orders  should  be 
estimated  separately,  so  that  the  production  department 
can  estimate  the  goods  to  be  produced  for  stock  and  those 
to  be  produced  to  order.  To  make  an  accurate  estimate  of 
the  probable  special  orders  to  be  received,  it  is  necessary  to 
make  a  careful  analysis  of  past  sales  to  learn  the  trend  of 
special  orders  by  years  and  by  territories.  The  effect  of 
market  conditions  on  the  number  of  special  orders  received 
may  also  be  useful.  The  policy  to  be  followed  in  handling 
special  orders — whether  they  are  to  be  given  the  right  of 
way  or  are  only  to  take  up  unused  time — will  have  a  con- 
siderable bearing  on  the  planning  for  their  control. 


THE  PRODUCTION  BUDGET 


139 


Whether  a  business  manufactures  on  standard  or  special 
orders,  the  first  step  in  the  planning  of  production  control  is 
the  preparation  of  the  estimate  of  production.  The  next 
step  is  to  provide  for  the  performance  of  this  estimate. 
This  involves  the  preparation  of  three  supplementary  es- 
timates: the  estimate  of  labor,  the  estimate  of  manufactur- 
ing expense,  and  the  estimate  of  materials.  When  goods 
are  produced  for  stock  it  is  necessary  to  take  into  considera- 
tion the  finished  goods  inventory  requirement  in  determin- 
ing the  production  requirements,  while  in  the  case  of  special 
orders  the  question  of  finished  goods  does  not  enter.  It  is 
necessary,  however,  to  estimate  carefully  the  quantity  of 
production,  so  that  the  necessary  labor  and  materials  may 
be  secured.  It  is  usually  urgent  to  produce  the  goods  called 
for  by  special  orders  as  quickly  as  possible,  which  makes  it 
the  more  imperative  that  plans  be  made  carefully,  so  that 
delays  will  not  result  from  a  lack  of  materials  or  labor. 

It  can  be  seen,  therefore,  that  the  preceding  discussion, 
with  the  exception  of  that  dealing  with  the  control  of  finished 
stock,  applies  equally  well  to  a  manufacturing  business 
producing  for  stock  and  to  one  producing  on  special  orders. 

Preparation  of  Production  Budget 

As  shown  by  the  foregoing  discussion,  the  production 
budget  is  the  result  of  a  coordination  of  the  sales  possibili- 
ties and  the  production  capacity.  Its  preparation  involves 
a  procedure  similar  to  the  following : 

I.  Preparation  of  Sales  Budget: 

1.  Sales  estimates  are  prepared  by  sales  units. 

2.  These  are  revised  by  the  general  sales  ofhce. 

3.  They  are  then  forwarded  to  the  production  department 

where  a  comparison  is  made  between  the  requirements  of 
sales  estimates  and  the  production  capacity.  If  the 
production  department  thinks  revisions  are  necessary 
these  are  shown  on  the  sales  estimates. 


I40 


BUDGETARY  CONTROL 


4.  Estimates  as  approved  by  the  production  department  are 
forwarded  to  the  budget  committee  for  final  revision  and 
approval.  This  committee  will  decide  any  differences 
which  may  exist  between  the  programs  of  the  sales  and 
the  production  department. 

II.  Preparation  of  .Finished  Goods  Budget: 

1.  Estimate  of  finished  goods  requirements  prepared  from  the 

sales  budget  by  the  production  department. 

2.  This  estimate  is  forwarded  to  the  budget  committee  for  its 

consideration  and  appro\-al. 

3.  After  the  estimate  of  finished  goods  is  approved  by  the 

budget  committee,  it  is  enforced  by  the  production  de- 
partment by  means  of  the  balance  of  stores  records 
operated  under  maximum  and  minimum  standards. 

It  will  be  noticed  that  the  "production  budget"  really 
resolves  itself  into  a  "finished  goods"  budget.  In  order  to 
carry  out  this  budget  it  is  necessary  to  prepare  supplemen- 
tary budgets  for  materials,  labor,  and  manufacturing 
expense. 

It  is  usually  necessary  to  have  the  production  budget 
prepared  in  the  office  of  the  production  manager.  It  is 
desirable  to  have  the  records  of  machine  capacity  centralized 
and  these  are  often  kept  in  the  central  office.  In  some  cases 
these  records  are  kept  by  the  planning  department,  which 
may  then  perform  the  detail  work  involved  in  the  prepara- 
tion of  the  production  budget,  whereupon  the  budget  will 
be  carefully  revised  by  the  production  manager  before  it  is 
submitted  to  the  budget  committee. 

Control  over  Production  Budget 

To  exercise  control  over  the  production  budget  and  to 
make  revisions  when  necessary,  monthly  reports  are  re- 
quired which  show  a  comparison  between  the  estimated  and 
the  actual  performance.  These  reports  will  vary  some- 
what, depending  on  the  one  for  whose  use  the  report  is 


THE  PRODUCTION  BUDGET 


142 


BUDGETARY  CONTROL 


intended.  The  balance  of  stores  records  are  intended  to 
enforce  automatically  the  production  budget;  but  no 
matter  how  carefully  these  records  are  operated,  errors  will 
occur  which  will  make  them  fail  to  accomplish  this  purpose 
perfectly.  When  these  errors  occur,  they  ought  to  be 
detected  as  quickly  as  possible  and  measures  taken  to 
remedy  them. 

For  the  use  of  the  general  officers  a  finished  stock 
budget  report  made  in  the  form  shown  in  Figure  8  is  very 
serviceable. 

This  report  serves  to  show  to  what  extent  coordination 
between  sales  and  production  is  being  achieved.  If  the 
commodities  sold  by  the  company  are  not  too  numerous, 
each  commodity  should  be  shown  on  this  report.  Where 
the  commodities  are  very  numerous,  it  will  be  necessary  to 
show  them  on  this  report  by  groups  or  classes.  In  this  case 
judgment  must  be  used  in  interpreting  the  report,  for  it  is 
obvious  that  there  might  be  very  close  coordination  be- 
tween the  sales  and  production  of  a  group  and  yet  there 
might  be  items  in  the  group  on  which  large  inventories 
existed  and  other  items  for  which  unfilled  orders  were  on 
hand. 

The  amount  shown  in  column  (2)  in  Figure  8  is  taken 
from  the  last  revision  of  the  sales  estimate.  Column  (3) 
shows  the  estimated  quota  for  finished  goods  based  on  the 
estimated  sales  shown  in  column  (2).  Column  (4)  shows 
the  actual  sales  for  the  month,  and  column  (5)  shows  the 
revised  finished  goods  quota,  the  revision  being  based  on  the 
actual  sales  as  shown  in  column  (4).  Column  (6)  shows 
the  actual  deliveries  to  stock  of  finished  goods.  Columns 
(2)  and  (4)  provide  a  comparison  of  estimated  and  actual 
production  for  the  month.  Columns  (5)  and  (6)  provide  a 
comparison  between  the  actual  production  and  the  revised 
production  quota.    A  comparison  of  columns  (3) ,  (5) ,  and 


THE  PRODUCTION  BUDGET 


(6)  will  show  two  things:  (a)  by  how  much  the  original 
estimate  of  production  was  incorrect;  and  (b)  how  much  the 
actual  production  varied  from  the  estimated.  The  informa- 
tion sho\\Ti  in  column  (4)  is  taken  from  the  sales  records  for 
the  month,  and  the  information  shown  in  column  (6)  is 
taken  from  the  balance  of  stores  records.  Column  (7) 
shows  the  difference  between  columns  (5)  and  (6).  Column 
(8)  shows  the  manufacturing  orders  outstanding  in  the 
factory  at  the  end  of  the  month.  These  orders  should  be 
shown  by  the  records  of  the  planning  department  and  also 
on  the  balance  of  stores  records.  Column  (9)  shows  the 
amount  to  which  the  production  budget  for  the  next  month 
should  be  revised. 

If  a  monthly  quota  system  is  maintained  on  stock 
deliveries,  the  unfilled  orders  at  the  end  of  the  month  as 
shown  by  this  report  furnish  valuable  data  for  use  in  pro- 
duction control.  It  is  possible  that  a  large  amount  of  un- 
filled orders  represents  poor  production  management.  In 
some  cases  these  unfilled  orders  may  be  due  to  traffic  mis- 
management, to  poor  warehouse  control  and  operation,  to 
general  trade  depression,  or  to  strikes  and  similar  causes. 
In  each  case  the  data  given  in  the  report  as  to  outstanding 
unfilled  orders  presents  material  for  executive  judgment, 
executive  orders,  and  executive  discipline  and  control. 
Such  a  budget  and  reporting  system  makes  use  of  sales, 
inventory,  and  production  accounts  as  a  basis  for  future 
plans.  The  reports  under  such  a  system  offer  comparisons 
between  estimated  sales  and  estimated  production,  and 
actual  sales  and  actual  production.  Such  reporting  makes 
constant  use  of  accounts,  and  the  requirements  of  the  re- 
ports to  be  made  determine  what  grouping  of  sales  ac- 
counts should  be  followed.  Similarly,  reporting  require- 
ments indicate  the  analysis  to  be  followed  in  classifying 
inventory  accounts  and  cost  sheets. 


144 


BUDGETARY  CONTROL 


Significance  of  Finished  Stock  Budget  Report 

Every  functional  officer  of  a  factory  has  his  own  partic- 
ular interest  in  the  showing  made  in  the  monthly  report  of 
delivered  and  undelivered  orders  under  the  monthly  quota. 
The  officer  in  charge  of  the  employment  of  labor  studies  the 
outstanding  orders  and  quota  balances  with  reference  to 
labor  that  may  be  needed  in  meeting  rush  deliveries  into 
stock.  The  traffic  manager  is  vitally  interested  in  out- 
standing orders,  since  the  amount  for  a  given  item  may  or 
may  not  indicate  the  necessity  for  action  as  to  terminal 
facilities,  warehousing,  reloading,  and  the  like.  The  ad- 
vertising manager  notes  with  concern  the  balances  in  quotas 
for  which  orders  have  not  been  placed,  since  such  balances 
may  indicate  a  departure  from  advertised  promises  of  serv- 
ice. Or  the  monthly  report  may  show  production  in 
excess  of  quotas  and  may  indicate  to  the  sales  manager 
the  necessity  for  extra  efforts  to  move  the  surplus  inven- 
tory. Of  course,  the  treasurer  is  interested  in  the  amount 
of  outstanding  orders  and  the  problem  of  financing  their 
production. 

The  monthly  report  discussed  in  the  foregoing  paragraphs 
furnishes  the  basis  for  immediate  management  decisions. 
It  also  provides  a  progressive  month-by-month  commentary 
on  the  accuracy  of  the  estimating  and  planning  in  the  busi- 
ness. Such  monthly  reports  reveal  errors  in  business  judg- 
ment and  make  for  better  estimating  for  the  next  budget 
period. 


CHAPTER  X 


THE  MATERIALS  BUDGET 

Need  for  Estimate  of  Materials 

After  the  finished  goods  which  are  to  be  produced  during 
the  budget  period  are  determined  by  means  of  the  produc- 
tion budget,  it  is  necessary  to  estimate  the  materials  which 
are  necessary  to  produce  these  goods.  This  estimate  is 
necessary : 

1.  That  the  purchasing  department  may  make  plans  by  which 

to  secure  the  necessary  materials  by  the  time  they  are 
needed  in  production, 

2.  That  the  treasurer  may  know  the  probable  disbursements  re- 

quired by  the  purchasing  program  and  can  plan  to  obtain  the 
funds  necessary  to  meet  these  disbursements. 

3.  That  the  budget  committee  may  be  able  to  see  the  financial  re- 

quirements of  the  proposed  sales  and  production  programs  at 
the  time  they  are  submitted  to  it  for  consideration.  It  will 
be  shown  in  a  later  chapter  that  all  the  departmental  budgets 
are  used  as  a  basis  for  the  preparation  of  a  financial 
budget,  which  the  budget  committee  uses  as  a  means  of  judg- 
ing the  desirability  of  the  proposed  budgets.  The  materials 
budget  usually  gives  rise  to  one  of  the  largest  of  the  disburse- 
ment items  on  the  financial  budget.  Its  use  is  therefore  essen- 
tial to  the  preparation  of  the  financial  budget. 

4.  The  materials  budget  is  also  necessary  for  the  preparation  of  the 

estimated  balance  sheet  and  estimated  statement  of  profit  and 
loss,  which  are  discussed  in  Chapters  XXI  and  XXII. 

Determination  of  Material  Requirements — By  Commodities 

In  the  same  manner  in  which  the  production  department 
maintains  an  analysis  of  each  of  its  products  to  show  the 
manufacturing  operations  required  in  its  production,  it 
should  maintain  an  analysis  which  will  show  the  materials 
10  145 


146 


BUDGETARY  CONTROL 


required  in  the  production  of  each  commodity.  By  the  use 
of  this  analysis  it  is  possible  to  estimate,  on  the  basis  of  the 
production  budget,  the  materials  which  will  be  required  to 
produce  the  goods  called  for  by  the  production  program. 
The  preferable  way  of  making  this  estimate  is  to  take  each 
item  on  the  finished  goods  or  production  budget,  and  to 
determine  the  amount  of  each  kind  of  material  which  will  be 
required  to  produce  it.  To  illustrate,  the  production  budget 
calls  for  the  manufacture  of  1,000  cast  iron  valves  of  X  size. 
The  product  analysis  shows  that  it  takes  4  pounds  of  pig 
iron  to  produce  this  valve.  Consequently  it  will  be  neces- 
sary to  purchase  4,000  pounds  of  pig  iron  to  make  possible 
the  production  of  the  1,000  valves.  If  each  item  on  the 
production  budget  which  requires  the  use  of  pig  iron  is  con- 
sidered in  this  manner,  the  total  purchases  of  pig  iron  can 
be  determined.  In  the  same  manner  each  item  on  the 
production  budget  will  be  considered  to  determine  the 
amount  of  materials  of  each  kind  that  is  necessary  for 
its  production. 

It  is  easy  to  see  that  this  method  of  determining  the 
material  requirements  may  in  some  circumstances  be  quite 
difficult.  In  the  first  place,  there  may  be  so  many  commodi- 
ties produced  and  so  many  different  kinds  of  materials  may 
enter  into  each  that  it  may  require  an  immense  amount  of 
clerical  work  to  determine  the  material  requirements  for 
each  commodity.  Again,  there  may  be  a  considerable  varia- 
tion between  the  quantity  of  raw  material  required  in  the 
production  of  a  commodity  and  the  quantity  of  material 
which  is  in  the  finished  product.  This  is  due  to  shrinkage 
and  waste,  which  are  usually  unavoidable.  If  this  shrink- 
age and  waste  are  fairly  uniform,  as  they  should  be  under 
normal  conditions,  it  is  possible  to  estimate  them  fairly 
accurately,  but  in  some  cases  it  is  difficult  to  estimate  their 
amount  with  any  accuracy. 


THE  MATERIALS  BUDGET 


147 


By  Ratios  of  Former  Periods 

In  some  cases,  instead  of  estimating  the  material  require- 
ments for  each  commodity  produced,  it  is  expedient,  in  order 
to  obtain  the  probable  material  requirements  for  the  period, 
to  find  the  ratio  between  the  production  volume  for  several 
periods  and  the  volume  of  materials  of  each  kind  required 
for  this  production,  and  apply  these  ratios  to  the  production 
budget  of  the  current  period.  These  estimates  will  be  more 
accurate  if  separate  ratios  are  determined  for  different  classes 
of  product  manufactured.  The  reason  for  this  is  apparent, 
for  different  quantities  of  raw  material  will  be  required  for 
different  classes  of  finished  product  and  the  ratio  between  the 
different  classes  is  apt  not  to  remain  the  same  during  dif- 
ferent periods. 

To  take  a  simple  illustration,  the  M  Manufacturing 
Company  produces  10,000  different  articles  which  can  be 
grouped  into  three  principal  classes,  known  as  Class  A, 
Class  B,  and  Class  C.  The  articles  in  each  class  are  com- 
posed of  the  same  materials  but  vary  as  to  size  and  design. 
The  three  principal  raw  materials  used  in  the  manufacture 
of  the  three  classes  are  the  commodities  X,  Y,  and  Z.  Each 
of  these  commodities  is  used  in  the  manufacture  of  each 
class,  but  in  varying  degrees.  Commodity  X  is  used  prin- 
cipally in  the  production  of  Class  A,  commodity  Y  princi- 
pally in  the  production  of  Class  B,  and  commodity  Z  prin- 
cipally in  the  production  of  Class  C.  It  may  be  assumed 
that  in  terms  of  pounds  the  ratios  are  as  follows : 

Class  A— Commodity  X  60%,  Y  20%,  Z  10% 
Class  B— Commodity  X  10%,  Y  60%,  Z  20% 
Class  C — Commodity  X  20%,  Y  10%,  Z  60% 

The  remaining  10  per  cent  in  each  case  is  composed  of  mis- 
cellaneous materials. 

If  the  ratio  between  the  tonnage  of  the  three  classes 


148 


BUDGETARY  CONTROL 


fluctuates  from  period  to  period,  it  can  be  readily  seen  that 
the  quantity  of  X,  Y,  and  Z  required  in  production  would 
fluctuate  accordingly.  For  instance,  if  it  is  determined  that 
it  is  desirable  to  increase  the  production  of  A  20  per  cent  and 
to  decrease  the  production  of  C  a  like  amount,  the  effect  on 
the  requirements  for  each  of  the  commodities  X,  Y,  and  Z 
is  apparent.  There  are  few  businesses  producing  several 
different  articles  in  which  the  ratio  between  the  volume  of 
these  articles  produced  each  year  does  not  vary  materially. 
The  foregoing  illustration  serves  to  show  that  if  such  varia- 
tions exist,  inaccuracies  will  result  from  estimating  the 
material  requirements  by  the  use  of  the  ratio  of  materials 
to  total  production. 

Standard  Material  Rates  as  an  Aid 

During  recent  years  accountants  and  industrial  engineers 
have  given  much  attention  to  the  development  of  standards 
by  which  to  judge  production.  The  principal  emphasis  has 
been  placed  on  standard  rates  for  manufacturing  expenses, 
but  there  has  been  some  consideration  given  to  the  develop- 
ment of  standard  rates  of  material  and  labor.  There  seems 
to  be  no  good  reason  why  standard  material  rates  should 
not  be  developed.  If  these  are  set  up  they  will  serve  at  least 
three  useful  purposes: 

1 .  They  can  be  used  in  the  estimating  of  costs  and  the  establishment 

of  prices  on  contracts. 

2.  They  will  serve  as  a  means  of  judging  the  efificiency  of  the  manu- 

facturing operations  and  will  assist  in  the  elimination  of  waste 
due  to  errors  or  improper  use  of  material.  By  comparing  the 
material  used  with  the  standard,  it  will  be  possible  to  locate  the 
excessive  use  of  material. 

3.  They  will  be  of  important  service  in  estimating  material  require- 

ments and  in  preparing  a  purchasing  program. 

Where  standard  rates  of  material  to  be  used  in  the  man- 
ufacture of  each  product  are  established,  the  task  of  pre- 


THE  MATERIALS  BUDGET 


149 


paring  the  materials  budget  is  greatly  lessened.  It  is  only 
necessary  to  multiply  the  standard  rate  of  material  set  on 
each  commodity  by  the  number  of  units  of  that  commodity 
which  is  to  be  produced,  to  determine  the  material  require- 
ments. 

Relation  of  Materials  Requirements  to  Materials  Inventory 

By  means  of  one  of  the  methods  explained  in  the  fore- 
going discussion  it  is  possible  to  estimate  the  materials  re- 
quired to  satisfy  the  production  program.  To  translate 
the  requirements  of  the  production  program  into  an  estimate 
of  materials  which  will  serve  as  a  basis  for  the  materials 
budget,  it  is  necessary  to  take  into  consideration  the  inven- 
tory of  materials  at  the  beginning  of  the  period  and  the 
estimated  inventory  of  materials  at  the  end  of  the  period. 

To  illustrate :  The  production  budget  calls  for  the  manu- 
facture of  1,000  articles  X,  and  it  is  estimated  that  it  will 
take  4,000  pounds  of  commodity  Y  to  produce  these.  The 
records  of  the  factory  show  that  the  inventory  of  com- 
modity Y  at  the  beginning  of  the  budget  period  is  1,300 
pounds,  and  it  is  estimated  that  an  inventory  of  1,200 
pounds  at  the  end  of  the  period  will  be  sufficient.  The  esti- 
mate of  materials  on  commodity  Y  for  the  period  will  be 
4,000  lbs.  +  i,200  lbs.  — 1,300  lbs.  =  3,900  lbs.  Each  com- 
modity which  is  to  appear  on  the  materials  budget  must 
be  treated  in  this  manner  if  an  accurate  estimate  is  to  be 
prepared. 

But  the  problem  of  the  purchasing  department  is  not 
merely  to  purchase  the  quantity  of  materials  that  are  to  be 
used  in  production  during  the  budget  period.  It  must  do 
more  than  that ;  it  must  purchase  the  materials  in  anticipa- 
tion of  factory  requisitions  and  place  them  in  the  storeroom 
so  that  the  needs  of  the  factory  may  be  served  promptly. 
An  easy  solution  of  this  problem  would  be  to  purchase  before 


BUDGETARY  CONTROL 


the  beginning  of  the  budget  period,  or  shortly  thereafter,  all 
the  materials  required  during  the  period.  For  example,  if 
the  officers  of  a  foundry  estimate  that  lOO  tons  of  pig  iron 
will  be  required  during  the  budget  period,  the  purchasing 
agent  may  purchase  and  have  on  hand  the  loo  tons  on  or 
before  the  first  day  of  the  period.  Such  a  procedure  is 
clearly  impracticable  except  in  rare  cases. 

In  the  first  place,  it  is  clearly  undesirable  to  purchase 
materials  in  complete  anticipation  of  production  require- 
ments because  of  the  large  amount  of  capital  required.  If 
this  procedure  is  followed,  a  large  part  of  the  capital  invested 
in  the  materials  is  tied  up  for  a  considerable  period  of  time 
before  the  materials  are  needed.  It  usually  is  desirable  not 
to  maintain  stocks  of  materials  on  hand  for  any  longer  period 
of  time  than  is  necessary  to  make  reasonably  sure  of  the 
prompt  satisfaction  of  factory  requisitions.  There  are  of 
course  circumstances  which  make  another  procedure  de- 
sirable, and  these  are  discussed  later  in  this  chapter. 

In  the  second  place,  it  is  usually  not  profitable  to  main- 
tain storehouses  of  sufficient  capacity  to  provide  space  for 
an  inventory  of  raw  materials  in  excess  of  that  needed  to 
meet  the  current  demands  of  the  production  program.  The 
space  required  for  such  storerooms  is  usually  costly  and  the 
labor  required  to  care  for  them  is  an  additional  expense. 
Again,  if  the  material  is  subject  to  deterioration  or  obso- 
lescence, it  may  decrease  in  value  during  the  time  it  is  left 
in  the  storeroom.  Insurance  and  taxes  may  also  be  in- 
creased because  of  its  possession. 

From  the  foregoing  it  can  be  seen  that  it  is  the  problem 
of  the  purchasing  department  to  schedule  deliveries  of  ma- 
terials so  that  a  sufficient  amount  of  materials  will  be  on 
hand  at  all  times  to  meet  the  production  needs  and  yet  not 
be  excessive  with  the  consequent  loss  arising  from  such 
excess.    To  accomplish  this  it  is  necessary  to  set  up  a 


THE  MATERIALS  BUDGET 


schedule  for  the  inventory  of  materials  to  be  maintained  and 
one  for  deliveries  which  will  maintain  the  inventory  schedule. 
The  ideal  schedule  would  be  one  which  delivered  to  stock 
each  day  the  exact  amount  of  goods  which  would  be  sold 
during  the  day.  If  such  a  schedule  could  be  maintained 
during  300  production  days  of  a  year,  the  materials  stock 
would  be  turned  over  300  times. 

Unfortunately  the  daily  factory  requisitions  are  not 
uniform  in  amount,  and  purchase  deliveries  cannot  be  en- 
forced with  sufficient  exactness  to  insure  a  uniform  daily 
delivery  to  stock;  consequently  it  is  impossible  to  deliver 
into  stock  each  day  the  amount  of  materials  that  is  to  be 
requisitioned  by  the  factory  on  that  day.  It  is  necessary, 
therefore,  to  carry  an  inventory  to  provide  for  the  lack  of 
coordination  of  purchase  deliveries  and  production  require- 
ments. It  is  the  problem  of  the  purchasing  department, 
acting  in  cooperation  with  the  production  department,  to  de- 
termine the  desirable  amount  for  this  inventory  and  to  plan 
a  purchasing  program  that  will  maintain  it  at  this  amount. 

The  inventory  of  materials  is  not  a  fixed  or  uniform 
amount.  Since  its  purpose  is  to  take  up  the  slack  between 
purchase  deliveries  and  production  requirements,  it  should 
be  evident  that  it  is  a  constantly  varying  amount.  Because 
of  its  constant  fluctuations,  it  is  necessary  that  an  effective 
control  be  exercised  over  it.  This  control  involves  the 
following : 

1.  The  establishment  of  maximum  and  minimum  limits,  to  serve  as 

a  check  on  its  size. 

2.  The  establishment  of  adequate  records  and  an  adequate  proce- 

dure to  enforce  these  limits. 

Maximum  and  Minimum  Limits  as  a  Basis  of  Inventory  Control 
Maximum,  minimum,  and  quantities  to  order  are  used  in 
the  same  manner  in  the  control  of  raw  materials  as  they  are 


152 


BUDGETARY  CONTROL 


used  in  the  control  of  finished  goods.  The  factors  which 
must  be  considered  in  the  estabUshment  of  these  quantities 
for  materials  are  somewhat  different  in  terminology  from 
those  which  determine  the  same  quantities  for  finished 
goods,  but  they  are  very  similar  in  nature.  Instead  of 
considering  the  production  period,  it  is  necessary  to  consider 
the  purchasing  period,  or  the  length  of  time  between  the 
sending  of  the  purchase  order  and  the  receipt  of  the  goods. 
Instead  of  considering  probable  sales,  it  is  necessary  to  con- 
sider the  probable  factory  requisitions  for  materials.  Instead 
of  considering  the  economical  run,  it  is  necessary  to  con- 
sider the  economical  quantity  to  purchase  with  reference  to 
terms,  price,  and  deliveries. 

The  method  by  which  these  facts  must  be  considered  in 
establishing  control  of  raw  materials  should  be  apparent 
after  the  rather  extensive  explanation  of  the  control  of  fin- 
ished goods  which  has  been  given  in  the  preceding  chapter. 

Record  of  Materials 

To  enforce  the  requirements  with  reference  to  maximum, 
quantity  to  order,  and  minimum,  it  is  necessary  to  maintain 
a  materials  record  which  provides  a  perpetual  inventory  of 
raw  materials.  The  maximum,  quantity  to  order,  and 
minimum,  as  established  for  each  item  of  materials,  will  be 
shown  on  the  materials  record.  Usually  this  record  is  kept 
on  what  is  termed  a  "balance  of  stores  form,"  which  is 
especially  adapted  for  exercising  effective  inventory  control. 

There  are  many  variations  in  the  form  of  the  balance  of 
stores  record.    A  typical  form  is  shown  in  Figure  9. 

To  illustrate  the  use  of  this  type  of  balance  of  stores,  the 
entries  appearing  thereon  will  be  explained.  Suppose  that 
on  the  day  the  balance  of  stores  record  is  opened,  April  i,  a 
physical  inventory  shows  that  there  are  12,500  pieces  in  the 
stockhouse  bin.    This  quantity  is  entered  in  the  balance 


THE  MATERIALS  BUDGET 


153 


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154 


BUDGETARY  CONTROL 


column.  This  column  shows  at  all  times  the  amount  on 
hand.  After  looking  through  the  files  of  factory  requisitions 
it  is  found  that  all  requisitions  for  this  particular  commodity 
have  been  filled  so  that  the  quantity  of  12,500  is  available 
for  use.  This  quantity  would  be  entered,  therefore,  in  the 
Available  or  Shortage  column.  An  examination  of  the  pur- 
chase order  files  shows  that  there  is  outstanding  a  purchase 
order  for  10,000  pieces  of  this  commodity,  this  amount  being 
the  Quantity  to  Order.  The  10,000  on  order  is  entered  in 
the  ordered  column.  The  record  is  now  ready  for  the  receipt 
of  the  current  entries. 

On  April  5  a  factory  requisition,  No.  E  6784,  is  received 
for  4,000 pieces.  The  number  4,000  is  entered  in  the  Applied 
column  and  substracted  from  the  amount  in  the  Available 
or  Shortage  column,  thereby  reducing  the  balance  in  this 
column  to  8,500.  On  April  10  the  quantity  specified  on 
requisition  E  6784  is  delivered  to  the  factory  and  an  entry 
is  made  in  the  Issued  column,  reducing  the  Balance  column 
to  8,500.  The  other  entries  for  requisitions  received,  bal- 
ance on  hand,  and  quantities  delivered  to  factory,  are  simi- 
lar to  the  ones  described  above.  On  May  i,  10,000  pieces 
of  stock  are  received  from  the  vendors  to  whom  purchase 
orders  have  previously  been  issued.  This  quantity  is  en- 
tered in  the  Received  column  and  added  to  the  quantity  in 
the  Balance  column  and  the  Available  or  Shortage  column. 

The  value  of  the  Applied  colunm  lies  in  the  fact  that  it 
makes  possible  the  reserving  of  materials  for  use  on  an  order 
though  it  may  not  be  desirable  to  requisition  them  from 
stock  at  once.  In  a  factory  operated  under  a  proper  plan- 
ning system,  a  "bill  of  materials"  showing  the  materials 
required  for  the  entire  order  is  prepared  for  each  production 
order  issued.  On  the  basis  of  this  bill  of  materials  entries 
are  made  on  the  materials  balance  of  stores  reserv^ing  the 
materials  needed  for  the  order.    Some  of  these  materials 


THE  MATERIALS  BUDGET 


may  not  be  taken  out  of  stock  for  several  days,  but  it  is  de- 
sirable that  they  be  reserved  so  that  there  will  be  no  danger 
that  the  order  may  be  delayed  because  of  the  lack  of  ma- 
terials. If  this  method  is  not  followed,  materials  may  be 
on  hand  when  the  order  is  issued  but  before  the  materials 
are  requisitioned  from  stock  they  may  have  been  used  on 
another  order. 

Relation  of  Purchasing  Policies  to  Materials  Budget 

In  the  preceding  discussion  it  has  been  assumed  that  the 
materials  budget  is  based  on  the  production  requirements 
and  that  the  purchases  will  be  scheduled  to  correspond  with 
the  production  schedule.  The  only  deviation  from  this 
assumption  which  has  been  recognized  in  the  foregoing  dis- 
cussion, is  that  in  establishing  quantities  to  order  care  must 
be  taken  to  see  that  the  quantities  stated  are  sufficient  to 
constitute  economical  purchases.  In  determining  what  con- 
stitutes an  economical  purchase  it  is  necessary  to  consider 
(i)  the  possibility  of  getting  lower  prices  or  better  terms 
by  making  larger  purchases,  and  (2)  the  possibility  of 
saving  in  freight  costs  by  purchasing  in  large  lots  instead 
of  small  ones.  In  each  case  it  is  necessary  to  balance  the 
savings  which  may  be  made  by  purchasing  in  large  quanti- 
ties against  (i)  the  loss  incurred  by  tying  up  capital  in  excess 
inventories,  (2)  the  possible  loss  due  to  deterioration  or  de- 
crease in  price  of  the  inventor^'',  and  (3)  the  possible  financial 
embarrassment  which  may  result  from  having  capital  in- 
vested in  inventory  which  cannot  be  quickly  realized. 

There  are  many  factors  which  may  affect  the  purchasing 
policy  of  a  firm,  and  there  are  some  of  these  which  are  op- 
posed to  the  control  of  purchases  by  budget.  For  instance, 
some  firms  think  it  is  a  function  of  the  purchasing  depart- 
ment to  speculate  on  market  changes  and  tendencies.  In 
these  firms,  during  periods  of  rising  prices,  large  quantities 


156 


BUDGETARY  CONTROL 


of  materials  will  be  purchased  and  deliveries  scheduled  far 
in  excess  of  production  demands.  It  is  undoubtedly  true 
that  under  these  circumstances  a  firm  may  make  large  sav- 
ings by  placing  large  orders  while  the  prices  are  increasing. 
It  obtains  materials  for  future  use  at  a  lower  price  than  it 
could  obtain  them  if  it  waited  to  purchase  them  when 
needed.  It  is  also  more  assured  of  their  delivery  than  if  it 
waited  until  their  purchase  is  indicated  by  the  materials 
budget. 

This  policy  is  apt  to  prove  a  dangerous  one  if  careful 
control  is  not  exercised.  If  the  purchasing  department  is 
once  given  the  opportunity  to  purchase  in  large  quantities, 
unrestrained  by  the  limitations  of  present  requirements  as 
shown  by  the  materials  budget,  it  is  apt  to  make  the  most 
of  its  opportunity  and  continue  the  policy  of  quantity  buy- 
ing as  long  as  prices  continue  to  rise.  When  the  turn  in 
prices  comes,  the  firm  is  apt  to  find  itself  burdened  with  an 
inventory  far  beyond  its  needs,  with  large  deliveries  sched- 
uled to  be  made  for  several  months,  all  of  which  has  been 
purchased  at  the  peak  of  prices.  In  many  cases,  even  if  the 
firm  escapes  serious  financial  embarrassment  it  loses  more 
on  its  high-priced  inventories  than  it  gained  from  the  quan- 
tity buying  during  the  period  of  rising  prices. 

A  falling  price  level  often  has  the  opposite  effect  on  the 
purchasing  policy  of  many  firms.  The  possibility  of  buying 
materials  in  the  near  future  at  reduced  prices  and  the  ease 
with  which  goods  can  be  procured  tend  toward  "hand-to- 
mouth"  buying.  It  is  very  desirable  to  exercise  caution 
during  a  period  of  declining  prices,  but  the  purchasing  policy 
may  be  so  conservative  that  it  will  result  in  a  decided  loss. 
Parsimonious  buying  may  result  in  unbalanced  inventories 
and  make  it  impossible  to  give  proper  service  to  customers, 
with  the  consequent  loss  of  trade.  Small  purchases  may 
also  result  in  higher  prices  and  freight  rates. 


1 


THE  MATERIALS  BUDGET 


157 


It  is  the  author's  opinion  that  the  purchasing  depart- 
ment is  not  equipped  to  speculate  and  that  it  is  not  its 
function  to  attempt  to  do  so.  We  have  not  yet  developed 
methods  of  forecasting  with  sufficient  accuracy  to  make  it 
possible  to  speculate  on  market  trends  without  the  incurring 
of  great  risk.  As  Mr.  Arthur  E.  Swanson  very  well  says  in 
the  November,  192 1  Ad^ninistration:  "The  difficulty  which 
even  very  experienced  and  well-trained  business  men  en- 
counter in  predicting  even  approximately  the  trend  of  price 
levels  and  business  activity,  has  caused  many  to  follow  a 
sort  of  straddling  policy  in  reference  to  economic  trends. 
They  do  not  buy  very  far  in  advance  when  the  level  ap- 
pears to  be  on  a  long  upward  swing,  or  very  close  when 
the  level  appears  to  be  on  a  downward  swing.  They  are 
satisfied  with  an  average  buy." 

Whatever  may  be  the  purchasing  policy  of  a  firm,  it  is 
the  function  of  the  materials  budget  to  show  the  materials 
required  by  the  production  program,  and  to  show  a  schedule 
of  deliveries  which  will  meet  the  needs  of  this  program.  If 
the  management  desires  to  disregard  the  purchasing  pro- 
gram shown  by  the  budget  in  order  to  carry  into  effect  pur- 
chasing policies  which  it  has  adopted,  that  is  its  privilege. 
It  is  the  opinion  of  the  author  that  it  is  only  in  exceptional 
cases  that  it  is  wise  for  it  to  do  so. 

The  "Stores"  Budget 

The  purchasing  department  purchases  not  only  the  ma- 
terials which  become  a  part  of  the  manufactured  product, 
but  also  numerous  "supplies"  which  are  used  in  carrying  on 
the  manufacturing  operations.  It  also  purchases  the  sup- 
plies used  by  all  the  operating  departments.  Under  a  well- 
developed  system  of  inventory  control  it  is  customary  to 
term  as  *'  stores  "  all  the  materials  purchased  for  all  purposes 
and  to  place  them  in  a  storeroom  from  whence  they  are 


158 


BUDGETARY  CONTROL 


requisitioned  for  use.  When  the  requisitions  are  issued  it 
is  indicated  whether  the  stores  for  which  they  call  are  to  be 
charged  as  "materials"  or  as  "supplies." 

Because  of  this  method  of  handling  materials  and  sup- 
plies, it  is  the  practice  of  some  finns  to  prepare  a  stores 
budget  which  takes  the  place  of  the  materials  budget.  The 
stores  budget  includes  the  estimated  purchases  for  both 
materials  and  supplies.  It  is  claimed  that  it  is  easier  for 
the  purchasing  agent  to  make  a  stores  budget  than  it  is  to 
estimate  separately  the  materials  and  supplies.  It  is  also 
claimed  that  it  is  easier  to  compare  the  estimated  with  the 
actual  performance  if  the  materials  and  supplies  are  shown 
in  one  budget.  This  contention  is  based  on  the  fact  that 
both  the  materials  and  supplies  are  charged  to  a  Stores 
account  when  purchased  and  are  not  distributed  as  between 
materials,  manufacturing  expense  (manufacturing  supplies 
are  charged  to  manufacturing  expense  when  consumed)  and 
departmental  expenses,  until  they  are  requisitioned  from  the 
storeroom  for  use.  Consequently  the  stores  accounts  give 
a  ready  means  of  checking  the  estimate  of  purchases,  while 
the  materials  and  manufacturing  expense  accounts  do  not, 
since  purchases  do  not  correspond  with  consumption  during 
any  specific  period. 

There  is  considerable  merit  in  these  contentions,  and  the 
author  has  found  it  advisable  in  some  cases  to  prepare  two 
budgets,  the  first  based  on  purchases  and  the  second  on  con- 
sumption. The  consumption  budget  is  essential  if  standard 
costs  are  to  be  established  for  material,  labor,  and  manufac- 
turing expense,  and  it  is  the  belief  of  the  author  that  such 
standards  are  essential  for  effective  production  control. 

Preparation  of  Materials  Budget 

After  the  production  budget  is  prepared,  the  production 
department  can  prepare  an  estimate  of  the  materials  re- 


THE  MATERIALS  BUDGET  159 

quired  to  produce  the  goods  called  for  by  this  budget.  If  a 
well-developed  planning  department  is  in  operation,  it  will 
have  available  data  which  will  make  it  possible  to  prepare 
this  estimate  without  difficulty.  In  such  cases  it  is  custo- 
mary to  delegate  the  preparation  of  the  materials  estimate 
to  the  planning  department.  After  its  preparation,  the 
materials  estimate  is  carefully  examined  by  the  production 
manager  and  his  staff.  If  there  is  not  a  planning  depart- 
ment in  operation,  the  estimate  of  materials  requirements 
will  be  prepared  by  the  staff  of  the  production  manager. 
After  the  estimate  of  materials  has  been  approved  by  the 
production  manager  it  will  be  transmitted  to  the  purchasing 
department,  which  will  make  an  estimate  of  the  purchases 
which  must  be  made  to  meet  the  estimate  of  materials. 

The  foregoing  procedure  is  not  always  followed.  In 
some  businesses  the  production  budget  is  sent  to  the  pur- 
chasing department,  and  it  is  required  to  estimate  both  the 
materials  required  and  the  purchases  which  are  necessary  to 
meet  these  requirements.  It  is  the  author's  opinion  that 
the  estimate  of  materials  can  best  be  made  by  the  produc- 
tion department,  since  it  usually  has  available  the  informa- 
tion which  is  necessary  for  its  preparation,  or  if  it  does  not, 
it  can  obtain  the  information  easily.  It  should  be  evident 
that  if  the  production  department,  through  the  planning 
department  or  otherwise,  prepares  bills  of  material  for  pro- 
duction orders,  it  must  have  available  data  from  which  it 
can  estimate  material  requirements.  If  the  purchasing  de- 
partment collects  the  data  necessary  to  make  this  estimate, 
it  will  usually  lead  to  a  duplication  of  data,  the  same  infor- 
mation being  collected  and  recorded  by  both  the  production 
and  the  purchasing  departments. 

In  other  businesses  the  production  department  prepares 
both  the  estimate  of  materials  and  the  estimate  of  pur- 
chases.   This  procedure  leads  to  equally  undesirable  results. 


i6o 


BUDGETARY  CONTROL 


The  purchasing  department  must  have  available  for  its  own 
use  the  data  necessary  for  the  preparation  of  the  estimate 
of  purchases;  and  if  this  task  is  undertaken  by  the  produc- 
tion department,  it  will  be  necessary  for  it  to  collect  dupli- 
cate data  which  it  is  not  as  well  qualified  to  interpret  and 
use  as  is  the  purchasing  department.  Furthermore,  the 
purchasing  department  may  rightly  resent  what  it  regards 
as  an  undue  usurpation  of  its  functions.  One  of  its  primary 
functions  is  to  collect  data  and  formulate  a  purchasing  pro- 
gram which  will  meet  the  needs  of  all  the  departments  and 
result  in  the  most  profit  to  the  company.  If  the  production 
department  prepares  the  estimate  of  materials  which  usually 
constitutes  the  major  part  of  the  purchases  made,  it  is 
depriving  the  purchasing  department  of  its  initiative  and 
judgment. 

Materials  Budget  Form 

As  in  the  case  of  all  other  forms  used  in  budgetary  con- 
trol, it  is  not  feasible  to  prescribe  a  form  for  the  materials 
budget  which  will  satisfy  all  conditions.  The  author  has 
found  the  form  shown  in  Figure  lo  serviceable  in  most  cases. 
The  illustration  is  designed  for  use  when  the  budget  period 
is  three  months  in  length.  If  the  period  is  for  a  longer  period 
of  time,  further  columns  may  be  added. 

In  most  cases  the  materials  budget  will  need  to  be  pre- 
pared prior  to  the  beginning  of  the  budget  period ;  therefore, 
all  the  information  shown  on  the  budget  report,  including 
the  beginning  inventory,  must  be  estimated.  The  estimated 
beginning  inventory  can  be  obtained  from  the  budget  report 
of  the  previous  period,  since  the  ending  inventory  of  one 
period  will  be  the  beginning  inventory  of  the  next  period. 
The  estimated  purchases  will  be  based  on  the  estimate  of 
materials  submitted  by  the  production  department,  with 
such  modifications  as  the  purchasing  department  may  think 


THE  MATERIALS  BUDGET 


i6i 


BUDGETARY  CONTROL 


necessary.  For  instance,  the  purchasing  department  may 
purchase  more  during  the  month  than  called  for  by  the 
materials  estimate  because  the  latter  amount  may  not  con- 
stitute an  economical  purchase.  The  estimated  inventory 
at  the  end  of  the  month  is  obtained  by  adding  the  estimated 
purchases  to  the  beginning  inventory,  and  substracting  the 
estimated  consumption  of  materials  as  shown  by  the  esti- 
mate of  materials  submitted  by  the  production  department. 
If  the  quantity  of  purchases  and  the  quantity  of  materials 
consumed  are  the  same,  the  beginning  and  ending  inventories 
will  be  the  same.  A  comparison  of  the  beginning  and  end- 
ing inventories  is  of  significance  to  the  budget  committee, 
since  in  case  of  an  increase  in  inventory  the  purchasing  de- 
partment may  be  asked  to  explain  the  cause. 

The  estimated  disbursements  for  purchases  of  previous 
months  can  be  obtained  from  the  unpaid  invoice  file.  The 
accounts  payable  section  of  the  accounting  department  may 
be  asked  to  supply  this  information,  since  this  section  main- 
tains the  unpaid  invoice  file.  The  estimated  disbursement 
for  purchases  of  the  current  month  will  be  determined  by 
estimating  the  time  of  delivery  of  the  purchases  and  allow- 
ing for  the  usual  discount  period.  It  can  be  readily  seen 
that  the  information  shown  in  this  column  can  be  only 
approximately  correct,  but  this  does  not  destroy  its  use- 
fulness, since  the  purpose  of  showing  the  estimated  dis- 
bursements on  the  materials  budget  is  only  to  indicate,  in  a 
convenient  form  for  the  use  of  the  treasurer  and  the  budget 
committee,  the  probable  financial  requirements  of  the 
contemplated  purchasing  program.  As  will  be  explained 
in  the  discussion  of  the  financial  budget,  these  estimates 
will  be  checked  and  revised,  if  necessary,  by  the  executive 
in  charge  of  the  budgetary  procedure  and  the  treasurer  in 
the  preparation  of  the  monthly  estimates  of  cash  receipts 
and  disbursements. 


THE  MATERIALS  BUDGET 


163 


After  the  estimate  of  material  purchases  is  prepared  by 
the  purchasing  department,  it  is  forwarded  to  the  executive 
in  charge  of  the  budget  procedure  and  is  transferred  by  him 
to  the  budget  committee,  together  with  the  other  depart- 
mental estimates  and  the  estimates  of  cash  receipts  and  dis- 
bursements which  are  prepared  from  the  departmental  esti- 
mates. After  the  estimate  of  materials  is  approved  by  the 
budget  committee,  it  is  transferred  by  the  executive  in 
charge  of  the  budget  committee  to  the  purchasing  depart- 
ment, whose  working  program  it  constitutes  for  the  budget 
period,  subject,  however,  to  monthly  revisions  which  may 
be  made  by  the  budget  committee. 

Control  of  Materials  Budget 

The  materials  budget,  like  all  other  budgets,  must  be 
checked  up  at  frequent  intervals  in  order  that  errors  in  the 
original  budget  may  be  detected  and  corrections  made  as 
quickly  as  possible.  To  make  this  possible  it  is  necessary  to 
have  a  monthly  report  which  will  provide  comparisons  be- 
tween the  estimated  and  the  actual  purchases.  The  report 
illustrated  in  Figure  1 1  will  ser\'e  this  purpose. 

The  purpose  and  value  of  the  information  shown  in  each 
column  of  this  report  should  be  evident.  The  executives 
should  study  this  report  in  the  light  of  the  production  for  the 
month  compared  with  the  estimated  production.  They 
should  also  give  consideration  to  the  comments  shown  in 
column  (8),  since  there  may  be  special  considerations  which 
have  brought  about  a  deviation  from  the  materials  budget. 
Such  deviations  should  be  made  as  a  general  rule,  however, 
only  in  response  to  executive  direction  or  permission.  This 
report  will  be  submitted  to  the  executive  in  charge  of  the 
budget  procedure,  and  will  be  transferred  by  him  to  the 
budget  committee  with  such  recommendations  as  he  may 
think  desirable.    By  a  study  of  this  report  the  budget  com- 


BUDGETARY  CONTROL 


mittee  will  be  able  to  make  such  revisions  as  are  necessary 
in  the  materials  budget  for  the  remainder  of  the  budget 
period.  These  revisions  will  be  communicated  to  the  pur- 
chasing department  by  the  executive  in  charge  of  the  budget 
procedure. 

It  is  evident  that  the  budget  committee  and  the  treasurer 
will  want,  in  addition  to  the  report  shown  in  Figure  1 1 ,  a 
report  which  will  show  the  disbursements  for  material  pur- 
chases during  the  month  compared  with  the  estimated  dis- 
bursements for  the  month. 


CHAPTER  XI 


THE  LABOR  BUDGET 

Need  for  Estimate  of  Labor 

After  the  finished  goods  which  are  to  be  produced  during 
the  budget  period  are  determined  by  means  of  the  produc- 
tion budget,  it  is  necessary  to  estimate  the  labor  required  to 
produce  these  goods.    This  estimate  is  necessary  in  order: 

1.  That  the  personnel  department  may  make  plans  to  have  avail- 

able the  necessary  workmen  at  the  time  they  are  needed  in 
production. 

2.  That  the  treasurer  may  know  the  probable  disbursements  re- 

quired by  the  labor  program  and  can  make  plans  to  obtain 
funds  for  these  disbursements. 

3.  That  the  budget  committee  may  be  able  to  see  the  financial  re- 

quirements of  the  proposed  sales  and  production  programs  at 
the  time  they  are  submitted  to  it  for  consideration.  The  labor 
budget  must  be  combined  with  the  selling  expense  budget,  the 
materials  budget,  and  the  other  budgets  requiring  disburse- 
ment of  funds,  in  order  to  show  the  total  disbursements  of  the 
budget  period,  before  the  budget  committee  or  the  board  of 
directors  can  judge  the  advisability  of  undertaking  the  financial 
obligations  imposed  by  the  proposed  budget  program. 

4.  The  estimate  of  labor  is  also  required  in  preparing  the  "general 

budget"  or  estimated  balance  sheet  and  statement  of  profit 
and  loss. 

It  is  particularly  important  that  the  personnel  depart- 
ment have  information  with  reference  to  the  labor  require- 
ments considerably  in  advance  of  the  time  when  it  is  neces- 
sary for  these  requirements  to  be  satisfied.  To  obtain  an 
efficient  working  force  is  not  an  easy  task,  and  capable 
workmen  cannot  be  secured  by  issuing  a  purchasing  order 
as  can  materials.    If  skilled  laborers  are  required,  the  task 

165 


BUDGETARY  CONTROL 


of  supplying  them  is  usually  not  an  easy  one.  In  many 
cases  they  must  be  trained  before  their  services  can  be  used 
effectively.  A  well-organized  personnel  department  will 
gather  information  of  its  own  accord,  which  will  afford  it  an 
approximate  estimate  of  the  labor  requirements,  but  it  docs 
not  have  an  approved  program  on  which  to  work  until  it 
receives  the  labor  budget. 

Determining  Labor  Requirements  by  Analysis  of  Each  Product 

In  the  same  manner  in  which  the  production  department 
maintains  an  analysis  of  each  of  its  products  to  show  the 
manufacturing  operations  and  materials  required  in  its  pro- 
duction, it  should  maintain  an  analysis  which  will  show  the 
labor  required  in  the  production  of  each  commodity.  If  a 
planning  department  is  in  operation  this  analysis  will  prob- 
ably be  maintained  by  this  department,  for  the  analysis  is 
necessary  for  its  use  in  preparing  time  tickets  for  distribu- 
tion to  the  different  departments  when  production  orders 
are  being  scheduled.  If  this  information  is  not  available  in 
the  planning  department,  it  may  be  available  in  the  estimat- 
ing department,  the  pay-roll  department,  or  the  personnel 
department.  If  none  of  these  departments  have  such 
records,  it  is  necessary  that  the  records  be  prepared  by  the 
staff  of  the  production  manager. 

By  the  use  of  this  analysis  it  is  possible  to  estimate,  on 
the  basis  of  the  production  budget,  the  labor  which  will  be 
required  to  produce  the  goods  called  for  by  the  production 
program.  The  preferable  way  of  making  this  estimate  is  to 
take  each  item  on  the  finished  goods  or  production  budget 
and  determine  the  amount  of  labor  of  each  kind  which  will 
be  required  to  produce  it.  To  illustrate:  The  production 
budget  calls  for  the  manufacture  of  1 ,000  units  of  articles  X 
of  Y  size.  The  product  analysis  shows  that  article  X  passes 
through  four  processes.    Process  A  requires  four  hours  of 


THE  LABOR  BUDGET 


labor,  process  B  two  hours,  process  C  three  hours,  and 
process  D  five  hours.  It  takes,  therefore,  a  total  of  four- 
teen hours  to  produce  one  unit  of  article  X.  If  i  ,000  are  to 
be  produced  it  will  take  a  total  of  14,000  hours.  It  is,  of 
course,  probable  that  the  labor  used  in  the  different  processes 
will  not  be  of  the  same  grade,  in  which  case  the  total  labor  re- 
quired for  each  process  will  need  to  be  estimated  separately. 
If  each  item  on  the  production  budget  is  considered  in  this 
manner,  it  will  be  possible  to  determine  the  total  labor  re- 
quirements of  the  production  program. 

Other  Methods  of  Estimating  Labor  Requirements 

It  is  easy  to  see  that  this  method  of  determining  the 
labor  requirements  may  in  some  circumstances  be  quite 
difficult.  There  may  be  so  many  commodities  produced 
and  so  many  different  kinds  of  labor  may  enter  into  each, 
that  it  may  require  an  immense  amount  of  clerical  work  to 
determine  the  labor  requirements  of  each  commodity. 

In  some  cases  it  is  thought  expedient  to  use  the  budget 
of  machine  capacity,  discussed  in  connection  with  the  pro- 
duction budget,  as  a  basis  for  estimating  labor  requirements. 
The  number  of  "machine  hours"  requiredby  the  production 
budget  having  been  obtained,  an  estimate  is  then  made  of 
the  workmen  who  will  be  required  to  operate  these  ma- 
chines. In  other  cases  it  has  been  found  expedient  to 
obtain  the  ratio  between  the  production  volume  for  several 
periods  and  the  volume  of  labor  of  each  kind  required  for 
this  production,  and  apply  these  ratios  to  the  production 
budget  of  the  current  period  to  obtain  the  probable  labor 
requirements.  These  estimates  will  be  more  accurate  if 
separate  ratios  are  determined  for  the  different  classes 
of  product  manufactured.  The  reason  for  this  is  ap- 
parent, for  different  quantities  of  labor  will  be  required 
for  different  classes  of  finished  product,  and  the  ratio 


BUDGETARY  CONTROL 


between  the  different  classes  is  apt  to  vary  from  period 
to  period. 

The  illustration  given  on  page  i6i  in  connection  with  the 
discussion  of  the  method  of  estimating  material  require- 
ments is  equally  applicable  to  the  determination  of  labor 
requirements. 

In  some  businesses  the  estimate  of  labor  requirements 
is  made  by  determining  the  labor  cost  per  unit  of  produc- 
tion for  several  periods,  and  then  applying  this  unit  cost  to 
the  estimate  of  production  for  the  current  period.  For 
instance,  it  may  be  determined  that  the  average  labor  cost 
as  shown  by  the  records  for  several  periods  is  $30  a  ton. 
The  estimate  of  production  calls  for  the  manufacture  of 
1,000  tons;  therefore  the  estimate  of  labor  is  $30,000.  If 
the  unit  cost  is  determined  carefully  and  is  calculated  sepa- 
rately on  each  product,  an  estimate  made  in  this  manner 
may  serve  satisfactorily  for  purposes  of  financial  control; 
but  it  does  not  provide  satisfactory  information  for  the  use 
of  the  personnel  department.  In  a  business  where  the  vol- 
ume of  production  is  fairly  uniform  and  the  working  force 
stable,  it  is  not  so  important  that  the  personnel  department 
receive  a  report  showing  labor  in  terms  of  hours.  It  must 
always  be  remembered  that  the  cost  of  obtaining  informa- 
tion must  be  balanced  against  its  value.  Budgetary  con- 
trol is  no  exception  to  the  general  rule  that  profit  and  loss  is 
the  ultimate  test  of  the  merit  of  any  method  of  administra- 
tive control. 

Use  of  Standard  Labor  Rates 

Some  of  the  most  valuable  work  of  industrial  engineers 
has  been  in  the  establishment  of  standards  by  which  to  judge 
labor.  The  first  work  performed  by  the  exponents  of  "scien- 
tific management"  was  the  establishment  of  standard  time 
limits  for  the  performance  of  tasks.    These  rates  were  first 


THE  LABOR  BUDGET 


established  in  connection  with  factory  labor  and  were  used 
to  speed  up  production.  There  seems  to  be  no  good  reason 
why  such  standard  rates  with  proper  modifications  might 
not  be  applied  to  all  departments  of  a  business  and  used 
very  extensively  in  the  enforcement  of  administrative  con- 
trol. It  is  interesting  to  note  that  a  large  manufacturing 
firm  in  the  East  is  now  scheduling  very  definitely  its  sales- 
men and  making  a  careful  study  of  how  each  employs  his 
time  with  the  intention  of  developing  standards  by  which 
to  judge  salesmen's  activities. 

Standard  labor  rates  serve  three  useful  purposes: 

1.  They  can  be  used  in  the  estimating  of  costs  and  in  the  establish- 

ment of  prices  on  special  orders  and  contracts. 

2.  They  serve  as  a  means  of  judging  the  efficiency  of  workmen.  If 

the  rates  are  fair  and  equitable,  a  workman's  efficiency  can  be 
judged  by  his  ability  to  reach  the  standard.  In  many  cases 
his  wages  are  based  on  the  standard,  so  that  he  has  an  incen- 
tive to  reach  or  exceed  the  standard  if  possible. 

3.  They  give  important  service  in  estimating  labor  requirements 

and  in  formulating  a  labor  program. 

Where  standard  rates  of  labor  to  be  used  in  the  man- 
ufacture of  each  product  are  established,  the  task  of  prepar- 
ing the  labor  budget  is  greatly  lessened.  It  must  be  remem- 
bered, however,  that  varying  conditions  may  make  the 
actual  labor  cost  more  or  less  than  the  standard,  and  it  is 
the  actual  as  near  as  it  can  be  estimated  which  is  necessary 
for  budgetary  control  purposes. 

Relation  of  Labor  Requirements  to  Production  and  Labor  Policies 

The  preceding  discussion  has  explained  the  method  of 
determining  the  amount  of  labor  required  to  produce  the 
amount  of  goods  called  for  by  a  production  program  based 
on  a  sales  program.  It  might  seem  from  the  discussion  that 
it  is  the  intention  to  advocate  that  the  production  program 
always  fluctuate  in  harmony  with  the  sales  program  and 


lyo  BUDGETARY  CONTROL 

that  the  labor  supply  be  made  to  fluctuate  with  the  produc- 
tion program.  If  this  could  be  done,  the  determination  of 
the  labor  requirements,  once  the  sales  requirements  were 
obtained,  would  be  merely  a  mathematical  process.  But 
the  formulation  of  a  labor  program,  which  is  a  prerequisite 
to  the  maintenance  of  an  effective  working  force,  is  not  so 
simple  as  this.  In  the  establishment  of  a  labor  program  it 
is  necessary  to  consider  not  only  the  immediate  but  also  the 
long-time  labor  requirements  of  a  firm.  This  leads  to  a 
consideration  of  both  the  production  and  labor  policies  of 
the  firm  in  question.  One  or  two  simple  illustrations  will 
assist  to  make  this  more  apparent. 

Previous  mention  has  been  made  of  the  fact  that  the 
production  program  may  not  be  varied  in  all  cases  to  cor- 
respond with  the  fluctuations  in  the  sales  program.  It  may 
be  impossible  to  control  the  fluctuations  in  the  sales,  al- 
though some  businesses,  notably  department  stores,  have 
done  much  towards  accomplishing  this  end.  But  the  vol- 
ume of  production  is  under  the  control  of  the  firm,  and 
within  the  limits  of  its  resources  can  be  varied  to  suit  its 
needs.  It  may  be  found  more  profitable  to  maintain  a 
uniform  production,  building  up  during  the  dull  season  an 
inventory  to  meet  the  excess  demands  of  the  rush  season, 
than  to  cause  the  production  program  to  fluctuate  in  har- 
mony with  the  sales  program.  This  procedure  may  provide 
for  a  better  use  of  equipment  and  make  possible  the  main- 
tenance of  a  more  stable  and  better  trained  working  force. 
If  this  policy  is  to  be  followed  it  must  be  kept  in  mind  when 
the  personnel  department  is  formulating  its  labor  program. 
It  is  apparent  that  the  labor  program  must  be  based  on 
a  "long  look  ahead"  rather  than  on  a  "flash-light  glimpse" 
of  the  present  condition. 

Some  business  firms  provide  homes  for  the  use  of  their 
workers,  charging  in  many  cases  a  nominal  rent  for  their 


THE  LABOR  BUDGET 


171 


use.  In  some  cases  the  business  is  located  in  a  village  and 
most  of  the  inhabitants  work  for  the  firm ;  and  in  case  work- 
men are  laid  off  during  dull  seasons,  it  is  necessary  that  they 
journey  to  another  village  to  obtain  work.  If  they  remain 
in  the  village  it  is  necessary  for  them  to  continue  to  live  on 
the  property  of  the  firm  unless  they  suffer  considerable 
hardship.  In  many  cases  the  workmen  regard  the  houses 
in  which  they  live  as  their  permanent  homes.  In  fact  one 
of  the  reasons  for  their  being  willing  to  work  for  the  small 
wages  they  usually  receive  in  these  cases  is  because  they 
expect  to  have  a  permanent  home.  In  such  cases  a  firm 
may  attempt  to  provide  some  work  for  all  its  employees 
during  each  month  of  the  year  if  possible.  If  necessary,  it 
will  reduce  wages  or  work  the  laborers  in  shifts,  so  that  each 
may  work  part  time,  but  it  will  attempt  to  retain  the  full 
personnel  on  the  pay-roll,  so  long  as  it  expects  to  need  them 
for  future  use.  In  carrying  out  this  policy,  it  may  pile  up 
inventory  during  dull  seasons  which  will  be  used  during  the 
rush  seasons. 

In  addition,  in  the  formulation  of  its  labor  program  each 
firm  must  consider  its  relations  to  labor  unions,  the  state 
labor  laws,  and  similar  agencies.  More  than  all,  it  must 
consider  its  attitude  towards  its  workmen,  its  welfare  pro- 
gram, and  the  long-run  policy  it  desires  to  maintain  in 
handling  its  labor  force. 

Like  any  other  administrative  device,  a  budget  should 
not  restrain  the  management  from  exercising  its  legitimate 
functions;  it  should  only  aid  the  management  by  providing 
information  which  will  serve  as  the  basis  for  judgments. 
This  is  particularly  true  of  the  labor  budget. 

The  Pay-Roll  Budget 

The  personnel  department  contracts  not  only  for  the 
personnel  which  is  necessary  to  perform  the  operations 


172 


BUDGETARY  CONTROL 


required  in  the  manufacture  of  the  product  of  the  firm,  but 
also  the  personnel  which  is  necessary  to  perform  the  supple- 
mentary operations  which  are  required  in  order  that  the 
manufacturing  operations  can  be  performed.  For  instance, 
it  employs  janitors  and  repair  men  as  well  as  machine  opera- 
tors. In  addition  it  employs  personnel  for  all  the  other 
departments  of  the  business  as  well  as  for  the  production 
department. 

In  consequence  of  this  situation  it  is  the  practice  of  some 
firms  to  prepare  a  pay-roll  budget  which  takes  the  place  of 
the  labor  budget.  The  pay-roll  budget  includes  an  estimate 
of  the  entire  pay-roll  of  the  company.  The  pay-roll  budget 
probably  arose  from  the  practice  of  having  the  labor  budget 
prepared  by  the  pay-roll  department.  This  department 
found  it  easier  to  make  an  estimate  of  its  total  pay-roll  than 
to  analyze  it  and  present  separate  estimates. 

Reasons  Against  Employment  of  Pay-RoU  Budget 

It  is  the  opinion  of  the  author  that  usually  this  plan  is 
not  desirable  for  the  following  reasons: 

1.  It  is  very  apt  to  lead  to  inaccurate  estimates.  It  is 
so  very  easy  to  add  or  substract  a  certain  amount  from  the 
total  and  report  the  result  as  an  estimate.  The  method 
usually  results  in  the  employment  of  ratios  between  pay- 
roll and  volume  of  business,  and  such  comparisons  are  un- 
satisfactory because  the  pay-roll  does  not  fluctuate  in  pro- 
portion to  volume  of  business. 

2.  The  pay-roll  budget  is  apt  to  make  difficult  an  accu- 
rate check  on  the  estimates.  If  it  contains  the  cost  of  the 
entire  pay-roll  of  the  company,  it  is  difficult  to  determine  the 
cause  of  the  variations  between  the  actual  and  estimated, 
which  are  bound  to  occur.  Furthermore,  the  amounts 
shown  on  the  budget  will  not  correspond  with  the  amounts 
shown  in  the  records,  since  the  pay-roll  in  the  latter  is  classi- 


THE  LABOR  BUDGET 


173 


fied  by  departments,  and  in  the  production  department 
direct  labor  is  recorded  under  labor,  while  indirect  labor  is 
recorded  as  manufacturing  expense. 

3.  It  is  desirable  to  have  each  functional  department 
prepare  an  estimate  of  its  total  expense,  including  its  pay- 
roll. This  procedure  requires  the  head  of  each  department 
to  consider  what  his  costs  have  been  and  what  he  plans  they 
will  be  in  the  future.  This  is  one  of  the  important  purposes 
of  the  budgetary  program,  and  the  budgetary  procedure 
should  be  designed  so  as  to  obtain  this  result. 

The  present  chapter  is  restricted  to  a  consideration  of 
the  ''direct"  labor  employed  in  production.  "Indirect" 
labor  will  be  considered  in  connection  with  the  manufac- 
turing expense  budget,  and  the  personnel  cost  of  the  func- 
tional departments  will  be  considered  in  connection  with  the 
budgets  of  these  departments. 

Preparation  of  Labor  Budget — Approved  Procedure 

After  the  production  budget  is  prepared,  the  production 
department  can  prepare  an  estimate  of  the  labor  required 
to  produce  the  goods  called  for  by  this  budget.  If  a  well- 
developed  planning  department  is  in  operation,  it  will  have 
available  data  which  will  make  it  possible  to  prepare  this 
estimate  without  difficulty.  In  such  cases  it  is  customary 
to  delegate  the  preparation  of  the  labor  budget  to  the  plan- 
ning department.  After  it  is  prepared  it  is  carefully  exam- 
ined by  the  production  manager  and  his  staff.  If  there  is 
not  a  planning  department  in  operation,  the  estimate  of 
labor  may  be  prepared  by  the  staff  of  the  production  depart- 
ment, the  pay-roll  department,  or  the  personnel  department. 
In  any  case  it  must  be  approved  by  the  production  manager. 

After  the  estimate  of  labor  requirements  is  approved  by 
the  production  department,  it  will  be  transmitted  to  the 
personnel  department,  which  will  make  an  estimate  of  the 


174 


BUDGETARY  CONTROL 


cost  of  the  labor  required.  In  some  cases  the  personnel  de- 
partment makes  an  estimate  of  the  labor  requirements  and 
then  transmits  the  estimate  to  the  pay-roll  department, 
where  the  estimated  cost  is  entered.  Thereafter  the  esti- 
mate of  labor  requirements  is  returned  to  the  personnel 
department  for  review. 

Less  Satisfactory  Methods  of  Preparing  Labor  Budget 

The  foregoing  procedure  is  not  always  followed.  In 
some  businesses  the  production  budget  is  sent  to  the  per- 
sonnel department,  or  to  the  pay-roll  department,  which 
must  estimate  both  the  labor  required  and  the  cost  of  secur- 
ing it.  It  is  the  author's  opinion  that  the  estimate  of  labor 
required  can  best  be  made  by  the  production  department, 
since  it  usually  has  available  the  information  necessary  for 
its  preparation. 

If  the  personnel  department  collects  the  data  necessary 
to  make  this  estimate,  it  will  usually  lead  to  a  duplication 
of  data,  since  the  same  information  will  be  collected  and 
recorded  by  both  the  production  and  personnel  depart- 
ments. It  is  admitted  that  some  of  this  information  is 
useful  and  even  necessary  for  the  personnel  department, 
but  it  is  not  necessary  to  have  it  in  as  great  detail  as  is 
required  for  making  the  estimate  of  labor. 

In  other  businesses  the  production  department  prepares 
both  the  estimate  of  labor  requirements  and  the  estimate  of 
labor  costs.  This  procedure  leads  to  equally  undesirable 
results.  The  personnel  department  must  have  available 
for  its  own  use  the  data  necessary  for  the  preparation  of  the 
estimate  of  labor  costs,  and  if  this  task  is  undertaken  by  the 
production  department,  it  will  be  necessary  for  it  to  collect 
duplicate  data  which  it  is  not  as  well  qualified  to  interpret 
and  use  as  is  the  personnel  department.  Furthermore,  the 
personnel  department  may  rightly  resent  what  it  regards 


THE  LABOR  BUDGET 


>  o  J;  1 


•525 


(0  c  ^  2 
«  EQ.Q- 


a  c  o"a 

to  3li  o 

i_  o  •:- 
<<  mCL 


Ratio  of  Cost 
of  Labor  to  Cost 

of  Production 
During  the 
Last  4  Periods 

\ 

1 

Ratio  of 
Actual  Cost 
of  Labor 
to  Actual 
Production 

 1 

BUDGET 

Ratio  of  Esti- 
mated Cost 
of  Labor  to 
Estimated 
Production 

Per  Cent 
of 

Increase 
Decrease 

N  LABOR 

Actual 
Labor 
Cost 

THLY  REPORT  01 

Estimated 
Labor 
Cost 

r  

Per  Cent 
Increase 
Decrease 

z 
0 

Actual 
Production 

Estimated 
Production 

1 

DEPARTIVIENT 

1 

176 


BUDGETARY  CONTROL 


as  an  undue  usurpation  of  its  functions.  One  of  its  primary 
functions  is  to  collect  data  on  labor  requirements  and  form- 
ulate a  labor  program  which  will  meet  the  needs  of  all  the 
departments  and  result  in  the  most  profit  to  the  company. 
"Labor  program"  is  here  used  in  a  broad  sense,  and  does 
not  refer  to  estimating  labor  costs  only.  If  the  production 
department  prepares  the  estimate  of  labor  cost,  it  may  be 
such  as  to  conflict  with  the  general  program  of  the  personnel 
department. 

Form  of  Labor  Budget 

The  author  has  found  the  form  shown  in  Figure  12  of 
service  in  the  presentation  of  the  labor  budget.  It  can  be 
modified  to  suit  the  needs  of  each  particular  case.  This 
form  is  intended  for  use  in  presenting  the  labor  budget  to 
the  budget  committee.  The  production  and  personnel  de- 
partments will  need  more  detailed  reports  in  preparing  the 
estimate.  The  illustration  is  designed  for -use  when  the 
budget  period  is  three  months  in  length.  If  the  period  is 
for  a  longer  period  of  time,  additional  columns  can  be  added. 

If  the  estimate  is  prepared  in  this  form,  it  will  be  possible 
for  the  budget  committee  to  determine  whether  the  current 
estimates  are  in  excess  of  past  expenditures,  and,  if  so,  what 
the  cause  of  the  increase  is.  If  this  increase  is  deemed 
unjustifiable,  the  estimate  can  be  revised  accordingly. 
The  value  of  the  monthly  distribution  to  the  treasurer  in  the 
preparation  of  his  cash  budget  is  quite  evident. 

It  may  be  desirable  to  show  an  analysis  of  the  labor  costs 
of  each  department.  At  least  the  production  and  personnel 
departments  will  employ  such  an  analysis. 

Approval  by  Budget  Committee 

After  the  estimate  of  labor  is  approved  by  both  the  pro- 
duction and  personnel  departments,  it  will  be  forwarded  to 


THE  LABOR  BUDGET 


177 


the  executive  in  charge  of  the  budget  procedure.  He  will 
transmit  it,  with  such  recommendations  as  he  may  think 
necessary,  to  the  budget  committee.  The  latter  will  con- 
sider it  in  connection  with  the  other  budgets  submitted  to 
it,  and  will  make  revisions  if  it  thinks  they  are  necessary. 
It  will  return  the  budget  as  approved  to  the  executive  in 
charge  of  the  budget  procedure,  who  will  transmit  a  copy  of 
it  to  the  production  and  personnel  departments. 

Control  of  Labor  Budget 

The  labor  budget,  like  all  other  budgets,  must  be  kept 
under  effective  control,  and  this  involves  the  preparation  at 
frequent  intervals  of  reports  which  provide  a  comparison 
between  the  actual  and  estimated  performance.  It  is 
usually  desirable  to  have  a  monthly  report  which  shows 
these  comparisons.  A  report  in  the  form  shown  in  Figure 
13  will  serve  this  purpose. 

The  purpose  and  value  of  the  information  shown  in  each 
column  of  this  report  should  be  evident.  The  executives 
should  study  this  report,  giving  particular  attention  to  the 
effect  of  any  variations  in  the  production  program  on  the 
labor  cost. 

This  report  will  be  submitted  to  the  executive  in  charge 
of  the  budget  procedure,  and  will  be  transferred  by  him  to 
the  budget  committee  with  such  recommendations  as  he 
may  think  desirable.  By  a  study  of  this  report  the  budget 
committee  will  be  able  to  make  such  revisions  as  are  neces- 
sary in  the  labor  budget  for  the  remainder  of  the  period. 
These  revisions  will  be  communicated  to  the  personnel  and 
production  departments  by  the  executive  in  charge  of  the 
budget  procedure. 


12 


CHAPTER  XII 


THE  WELFARE  EXPENSE  BUDGET 

Relation  of  Welfare  Expense  to  Labor  Cost 

The  preceding  chapter  has  dealt  with  the  method  of  esti- 
mating and  controlling  the  cost  of  labor  used  in  manufac- 
turing operations,  in  so  far  as  that  cost  is  represented  by 
the  wages  paid  to  workmen.  But  all  firms  incur  some 
expense  in  the  securing  and  maintenance  of  the  labor  force, 
in  addition  to  the  compensation  paid  to  the  members  of  this 
force.  This  expense  for  the  purpose  of  budget  making  may 
be  divided  into  two  groups : 

1.  "  Welfare "  expense 

2.  Administrative  expense  of  the  personnel  department 

It  is  the  purpose  of  the  present  chapter  to  treat  of  the 
first  of  these,  while  the  second  will  be  discussed  in  Chapter 
XVIII  in  the  treatment  of  the  expense  budgets.  It  is  not 
always  easy  to  make  a  clear  line  of  demarcation  between 
these  two  classes  of  expenses,  but  the  following  discussion 
will  serve  to  show  certain  distinguishing  features  between 
the  two. 

Practically  all  large  industrial  and  mercantile  firms  now 
place  considerable  emphasis  upon  desirable  working  condi- 
tions for  their  employees  as  a  basic  factor  in  labor  expense 
control.  The  welfare  of  the  employee  is  studiously  consid- 
ered from  the  standpoint  of  his  loyalty  to  the  employer  as 
well  as  from  the  standpoint  of  his  efficiency  as  a  productive 
workman.  His  health  and  personal  habits  have  an  impor- 
tant bearing  also  upon  his  availability  for  service  now  and 
in  the  future  as  a  trained  employee. 

178 


THE  WELFARE  EXPENSE  BUDGET 


179 


Classification  of  Welfare  Expense 

The  large  corporations,  under  their  welfare  plans,  incur 
various  kinds  of  expense.  Programs  for  better  conditions 
of  employment  usually  include  at  least  medical  inspection, 
first-aid  medical  services,  and  restrooms  for  women  em- 
ployees. These  programs  may  include  any  or  all  of  the 
following  classes  of  expense : 

1.  Medical  inspection 

2.  Medical  attendance  and  hospital  expense 

3.  Payment  of  wages  while  on  sick  leave 

4.  Dental  inspection  and  dental  work 

5.  Inspection  of  the  eyes  and  fitting  of  glasses 

6.  Picnics,  dances,  and  other  entertainments 

7.  Night  classes  in  English,  civics,  arithmetic,  and  other  elemen- 

tary subjects 

8.  Tuition  in  evening  schools  of  commerce 

9.  Restrooms 

10.  Gymnasiums 

11.  Prizes  for  athletic  and  literary  contests 

12.  Lunches  free  or  at  cost 

13.  Books  and  magazines 

14.  Contributions  to  savings  fund 

15.  Contributions  to  pension  and  old-age  retirement  funds 

The  foregoing  list  is  intended  to  be  suggestive  of  the 
kinds  of  expenditures  which  may  be  incurred  in  improving 
the  working  conditions  of  the  employee.  It  is  not  the  func- 
tion of  this  discussion  to  pass  judgment  on  the  nature  of  this 
work  or  the  kind  of  expenditures  which  it  should  include. 
That  problem  lies  in  the  field  of  personnel  management. 
But  granting  that  certain  kinds  of  expenses  exist,  it  is  the 
province  of  the  budgetary  program  to  effect  their  control. 
It  is  also  unnecessary  to  enter  here  into  a  discussion  of  the 
title  by  which  these  expenses  should  be  known.  There  are 
some  who  object  to  the  term  "welfare  expense"  because  it 
is  thought  that  it  has  an  improper  connotation.  From 


i8o 


BUDGETARY  CONTROL 


the  viewpoint  of  our  problem  the  title  of  this  expense  is 
immaterial. 

Relation  of  Welfare  Expense  to  Functional  Departments 

The  welfare  expenses  are  largely  impersonal.  The  basis 
for  welfare  work  must  be  democratic  if  it  is  to  result  in  in- 
creased loyalty  and  self-improvement  on  the  part  of  the 
average  employee.  This  requirement  leads  to  the  opening 
of  all  the  advantages  to  each  employee  alike,  whether  the 
employee  is  an  ofhcer  of  the  company  or  a  machine  helper. 
It  is  sometimes  necessary  to  make  exceptions  to  this  rule, 
but  they  should  be  as  few  as  possible.  All  employees  alike 
are  required  to  submit  to  medical  inspection,  all  employees 
alike  are  given  medical  service,  all  are  permitted  to  use  the 
gymnasium,  and  all  share  in  the  pension  fund,  although  their 
share  may  be  affected  by  their  previous  earning  power. 

Because  of  this  impersonal  character  of  practically  all 
welfare  expense,  it  is  not  possible  to  charge  any  particular 
item  of  it  as  a  part  of  the  direct  cost  of  a  particular  job  or  as 
a  direct  charge  to  the  expenses  of  a  particular  operating  de- 
partment of  the  business.  It  may  be  that  more  employees 
of  the  production  department  avail  themselves  of  the  use  of 
the  bowling  alley  than  employees  of  the  sales  department, 
but  this  does  not  warrant  charging  the  major  part  of  the 
expenses  of  maintaining  the  bowling  alley  to  production 
expense.  In  most  cases  the  clerical  employees  will  make 
greater  use  of  the  books  and  magazines  than  will  the  manual 
laborers ;  but  so  long  as  the  publications  are  available  for  the 
use  of  all  the  departments,  they  cannot  be  treated  as  an 
expense  of  any  particular  department. 

The  independent  nature  of  the  welfare  expense  of  any  of 
the  departments  is  seen  also  if  the  purpose  of  the  expense 
is  considered.  For  example,  a  physical  examination  of  each 
employee  may  be  required  to  prevent  possible  poor  health 


THE  WELFARE  EXPENSE  BUDGET  l8l 

or  breakdown  of  any  necessary  or  trained  employee.  All 
this  is  general  expense.  We  cannot  say  accurately  that  any 
part  of  this  expense  has  been  incurred  for  the  benefit  of  a 
particular  laborer  or  even  for  the  benefit  of  a  particular  pro- 
ductive unit  or  operating  department.  All  departments  are 
benefited  by  the  maintenance  of  an  efficient  working  force. 

Again  a  part  of  welfare  expense  is  incurred  wath  the  idea 
of  creating  loyalty  on  the  part  of  the  employees  towards  the 
company.  It  is  desired  that  they  should  be  stimulated  to  a 
definite  feeling  of  cooperative  interest  in  their  fellow  em- 
ployees. Thus,  the  bowling  club  prize,  awarded  by  the 
president  of  the  company  to  the  winner  of  the  individual 
high  score  in  the  contest  open  to  all  employees,  is  by  no 
means  to  be  charged  directly  to  the  department  where  the 
winner  is  employed. 

The  foregoing  discussion  and  illustrations  should  be 
sufficient  to  show  that  welfare  expense  is  general  in  nature 
and  is  seldom  particular  to  any  employee  or  department. 
The  welfare  expense  budget  is  discussed  in  connection  with 
the  several  budgets  prepared  for  manufacturing  operations, 
because  it  is  in  connection  with  manufacturing  industries 
that  the  administration  of  personnel  has  been  most  difficult 
and  the  need  for  welfare  work  has  been  most  felt;  but  it  is 
not  intended  to  imply  that  this  expense  is  primarily  for  the 
benefit  of  the  production  department.  In  a  manufacturing 
business  the  bulk  of  the  personnel  will  usually  be  in  the  pro- 
duction department  and  the  greatest  fluctuations  in  the 
number  of  personnel  will  also  occur  here,  so  that  in  esti- 
mating the  amount  of  the  welfare  expense  it  is  necessary 
to  give  careful  consideration  to  the  production  program. 

Estimating  Welfare  Expense — Per  Capita  Cost  Method 

Welfare  expense  will  be  incurred  in  the  case  of  any  par- 
ticular concern  to  the  extent  that  the  concern  finds  it  profit- 


BUDGETARY  CONTROL 


able  to  improve  its  conditions  of  employment  so  as  (i)  to 
compete  with  other  concerns  as  a  place  of  continuous  em- 
ployment, and  (2)  to  improve  the  efficiency  of  its  workmen. 
A  business  with  a  factory  located  in  a  country  town  will  not 
find  it  necessary  to  incur  certain  expenses  to  so  great  an 
extent  as  will  a  business  whose  factory  is  located  in  a  con- 
gested tenement  district.  The  former  will  incur  less  for 
medical  services  and  in  the  maintenance  of  sanitary  condi- 
tions. On  the  other  hand,  it  may  find  it  worth  while  to 
maintain  homes  for  its  employees  in  order  to  attract  a  better 
class  of  workmen  to  live  in  the  semi-rural  locality,  and  thus 
incur  an  expense  not  common  to  industrial  firms  located  in 
cities. 

There  is  no  means  by  which  welfare  expense  can  be  de- 
termined exactly.  It  will  vary  with  the  number  of  employ- 
ees, and  will  also  vary  from  month  to  month  and  year  to 
year,  given  the  same  number  of  employees.  For  in- 
stance, an  epidemic  may  break  out  at  any  time  which 
will  require  additional  expense  for  medical  inspection  and 
service. 

Perhaps  the  best  method  of  estimating  the  amounts  for  a 
budget  on  welfare  expense  is  to  determine  the  per  capita 
cost  of  each  class  of  expense,  and  then  to  multiply  the  aver- 
age per  capita  cost  of  past  years  by  the  estimated  average 
number  of  employees  for  the  coming  period.  If  the  per 
capita  method  is  employed  as  a  basis  for  estimating  welfare 
expense,  it  is  desirable  to  have  a  report  showing  the  amount 
of  each  class  of  expense  in  past  years.  Then  if  statistics 
can  be  had  as  to  the  average  number  of  employees  in  past 
years,  the  amount  of  money  spent,  say,  for  doctors  and 
nurses  in  192 1,  can  be  divided  by  the  average  number  of 
employees  for  1921  to  obtain  the  per  capita  expense  during 
this  year.  If  it  is  thought  that  the  same  per  capita  cost 
should  be  maintained  during  the  year  1922,  the  per  capita 


THE  WELFARE  EXPENSE  BUDGET 


183 


cost  of  1 92 1  will  be  multiplied  by  the  estimated  average 
number  of  employees  for  1922  to  obtain  the  estimated  total 
expense  for  1922.  Itwill  be  noticed  that  by  this  method  it  is 
assumed  that  the  expense  is  for  the  benefit  of  all  employees 
alike.  It  would  seem  that  this  is  proper,  since  doctors  and 
nurses  are  employed  not  for  the  benefit  of  any  particular 
employees,  but  for  the  welfare  of  all  as  a  productive  group. 

Points  to  be  Allowed  for  in  Estimating  Welfare  Expense 

It  may  be  desirable  to  work  out  two  per  capita  figures 
for  the  past  year:  first,  a  per  capita  cost  of  all  employees; 
and  second,  a  per  capita  cost  based  on  the  number  of  only 
those  employees  who  have  been  directly  benefited  by  the 
kind  of  welfare  expense  under  consideration.  Thus  the  per 
capita  cost  in  1921  for  entertainments  should  be  the  per 
capita  cost  for  all  employees  whether  or  not  they  have 
attended  the  entertainments.  The  per  capita  cost  should 
be  figured  on  the  average  number  of  employees,  since  enter- 
tainments are  open  to  all  employees.  As  a  secondary  figure, 
it  mcy  be  useful  to  have  the  per  capita  cost  of  entertainment 
expense  based  on  the  actual  number  of  employees  who  have 
attended  the  entertainments. 

If  the  plant  is  subject  to  periodical  shut-downs  due  to 
irregular  volume  of  business,  or  to  seasonal  strikes  resulting 
from  adjustments  of  wage  scales,  or  for  other  reasons,  it  will 
be  necessary  to  distinguish  between  (i)  per  capita  average 
for  continuing  expense,  such  as  the  salaries  of  the  head  sur- 
geon, the  head  nurse,  the  librarian,  etc.,  and  (2)  per  capita 
per  diem  average  for  all  expenses  that  are  incurred  only 
during  the  days  of  actual  plant  operation.  For  example,  a 
per  capita  per  diem  limitation  may  be  set  on  free  lunches, 
gymnasium  operating  expenses,  and  similar  expenses  which 
are  incurred  day  by  day  according  to  the  fluctuating  num- 
ber of  employees. 


BUDGETARY  CONTROL 


It  is  necessary  to  use  the  average  number  of  employees 
in  arriving  at  per  capita  cost.  In  any  large  industrial  or 
mercantile  business  there  will  be  a  larger  number  of  individ- 
ual names  that  have  appeared  on  the  pay-rolls  during  the 
year  than  the  average  number  continuously  employed. 
Thus  one  man  may  be  employed  on  a  job  from  January  to 
March  inclusive,  another  man  from  March  to  August  inclu- 
sive, and  still  another  man  from  September  to  December 
inclusive.  This  gives  three  employees,  if  we  are  consider- 
ing the  total  number  of  employees  actually  engaged  during 
the  year.  From  the  standpoint  of  the  average  number  of 
employees,  these  three  men  constitute  only  one  employee, 
since  taken  together  their  services  have  equaled  the  serv- 
ices of  one  man  employed  continuously  throughout  the 
year. 

If  it  is  possible  to  do  so,  labor  turnovers  should  be  figured 
from  two  different  standpoints.  First,  the  turnover  of 
labor  on  account  of  irregular  volume  of  business  should  be 
determined.  For  example,  a  thousand  men  may  be  dis- 
charged in  May  simply  because  there  is  no  work  for  them, 
and  a  thousand  new  men  may  be  employed  in  September, 
because  a  new  volume  of  work  has  been  obtained.  This 
labor  turnover  is  due  to  irregularity  of  volume  of  sales  and 
production,  and  should  be  distinguished  from  the  labor 
turnover  caused  by  dissatisfaction  of  employees. 

In  estimating  the  average  number  of  employees  for  a 
particular  year,  consideration  should  first  be  given  to  the 
sales  program  of  that  year  as  an  index  to  the  labor  program 
that  will  probably  result  from  irregular  volume  of  business. 
The  result  thus  obtained  must  be  modified  by  consideration 
)f  the  labor  turnover  in  the  year  in  question,  that  may  pre- 
sumably result  from  nonnal  dissatisfaction  of  individual 
employees  or  from  strikes  and  other  manifestations  of  labor 
jnrest. 


THE  WELFARE  EXPENSE  BUDGET  185 


BUDGETARY  CONTROL 


Preparation  of  Welfare  Expense  Budget 

The  control  of  welfare  expense  or  the  expense  of  condi- 
tions of  employment,  like  the  control  of  any  other  activity  in 
the  business,  demands  first  of  all  that  a  budget,  or  estimate, 
or  program,  or  quota,  be  set  up,  indicating  the  plans  for 
welfare  expense  for  the  coming  period.  This  budget  should 
show  information  for  each  distinctive  class  of  welfare 
expense.  For  instance,  it  may  show  the  welfare  expense 
classified  under  the  fifteen  headings  given  on  page  179.  In 
form  the  welfare  expense  budget  may  be  as  shown  in  Figure 
14.  The  purpose  of  each  of  thecolumn  headings  is  apparent. 

The  welfare  expense  budget  should  be  prepared  by  the 
personnel  department.  It  should  be  based  on  the  general 
plans  of  the  business  as  shown  by  its  various  departmental 
estimates,  and  should  be  in  harmony  with  the  general  poli- 
cies which  have  been  adopted  by  the  company.  The  per- 
sonnel manager  should  discuss  with  the  budget  committee 
prior  to  the  preparation  of  the  estimate  of  welfare  expense, 
any  new  plans  which  he  desires  to  inaugurate,  so  that  he 
may  have  the  benefit  of  the  judgment  of  the  principal  execu- 
tives of  the  company  in  its  preparation. 

The  personnel  manager  will  transmit  the  welfare  budget 
with  his  approval  to  the  executive  in  charge  of  the  budget 
procedure.  The  latter  will  transmit  it  to  the  budget  com- 
mittee with  any  comments  he  thinks  necessary.  The 
budget  committee  will  make  any  revisions  which  it  may 
think  are  required  and  return  the  budget,  with  its  approval, 
to  the  executive  in  charge  of  the  budget  procedure.  The 
latter  will  return  it  to  the  personnel  manager. 

Control  of  Welfare  Expense  Budget 

The  budget  on  welfare  expense  is  effective  only  if  a 
monthly  report  is  prepared,  showing  the  information  given 
in  the  seven  columns  of  the  welfare  budget  contrasted  with 


THE  WELFARE  EXPENSE  BUDGET 


187 


actual  number  of  employees  reported,  and  actual  amount  of 
expense  for  each  class  of  welfare  expense,  and  actual  per 
capita  cost.  This  report  may  be  made  in  the  form  shown 
in  Figure  15. 

It  is  quite  likely  that  the  actual  per  capita  will  vary  to  a 
considerable  degree  from  the  estimated  per  capita,  but  the 
budget  report  does  furnish  a  basis  for  planning  welfare 
expense  and  also  offers  the  means  whereby  the  management 
responsible  for  welfare  expense  can  keep  such  expense 
within  reasonable  control. 

The  monthly  report  will  be  submitted  by  the  executive 
in  charge  of  the  budget  procedure  to  the  budget  committee, 
and  the  latter  may,  if  it  thinks  this  report  shows  the  neces- 
sity, make  revisions  in  the  welfare  expense  budget.  The 
executive  in  charge  of  the  budget  procedure  will  communi- 
cate these  changes  to  the  personnel  manager. 


CHAPTER  XIII 


THE  MANUFACTURING  EXPENSE  BUDGET 

Need  for  Estimate  of  Manufacturing  Expense 

After  the  finished  goods  which  are  to  be  produced  during 
the  budget  period  are  determined  by  means  of  the  pro- 
duction budget,  it  is  necessary  to  estimate  the  manufactur- 
ing expenses  which  are  necessary  to  produce  these  goods. 
This  estimate  is  necessary  in  order — 

1.  That  the  various  departments  which  are  responsible  for  securing 

the  "services"  which  compose  manufacturing  expense,  may 
make  plans  to  have  these  services  by  the  time  they  are 
needed  in  production.  The  nature  of  these  services  and  the 
departments  responsible  for  their  procurement  will  be  explained 
later  in  this  chapter. 

2.  That  the  treasurer  may  know  the  probable  disbursements  re- 

quired by  the  manufacturing  expense  program  and  can  plan 
to  obtain  the  funds  needed  for  these  disbursements. 

3.  That  standard  rates  for  manufacturing  expense  may  be  estab- 

lished more  accurately.  The  method  of  establishing  such 
rates  is  discussed  later. 

4.  That  the  budget  committee  and  the  board  of  directors  may  be 

able  to  see  the  financial  requirements  of  the  proposed  sales 
and  production  programs  at  the  time  they  are  submitted  for 
consideration,  and  that  they  may  see  the  effect  of  the  manu- 
facturing expense  cost  on  the  estimated  financial  statements. 
In  addition  they  should  be  able  to  see  the  relation  of  the 
volume  of  production  to  the  manufacturing  expense.  The 
significance  of  this  relationship  will  be  explained  later  in  the 
chapter. 

The  reader  will  notice  that  the  estimate  of  manufactur- 
ing expense  combined  with  the  estimate  of  labor  and  the 
estimate  of  materials  constitutes  the  estimated  cost  of 

188 


1 


THE  MANUFACTURING  EXPENSE  BUDGET 


189 


the  manufactured  product,  since  the  elements  of  manu- 
facturing cost  are  materials,  labor,  and  manufacturing 
expense. 

Definition  of  Manufacturing  Expense 

The  costs  incurred  in  the  production  of  the  finished 
product  are  divided  into  two  broad  classes,  "direct"  costs 
and  "indirect"  costs. 

Direct  costs  are  payments  or  charges  for  labor  and  material 
expended  upon  a  definitely  determined  unit  or  product.  Small 
costs,  however,  are  not  charged  directly  to  the  product,  even  when 
the  latter  can  be  determined,  unless  the  increased  accuracy  of  the 
records  justifies  the  clerical  work  entailed.  It  follows,  therefore, 
that  indirect  costs  are  those  which  cannot  be  charged  economically 
or  directly  to  the  product.  An  example  of  a  direct  cost  is  the  cost 
of  the  raw  material  in  a  chair.  Indirect  costs  arise  from  the  fol- 
lowing sources: 

1.  Indirect  material — good  examples  of  which  are  rags  used  to 

wipe  off  chairs  and  tools;  or  new  tools  used  to  replace  those 
discarded. 

2.  Indirect  labor — for  instance,  wages  of  foremen  who  super- 

vise the  employees  in  several  departments  where  chairs  are 
made. 

3.  Fixed  charges — depreciation,  taxes,  insurance,  etc. 

Adherence  to  the  above  cost  classification  adds  to  the  accuracy 
of  the  records  for  this  reason:  By  charging  items  directly  to  the 
cost  units  (when  economical),  the  remaining  costs  (indirect  costs) 
are  less  than  if  certain  items  legitimately  "direct"  were  treated  as 
indirect  costs.  Indirect  costs  are  distributed  over  the  product  in 
as  accurate  a  manner  as  possible,  but  such  charging  is  less  accurate 
than  direct  charging.  For  instance,  raw  material  can  be  accurately 
measured  and  charged  directly  against  the  chair.  The  depreciation 
of  the  equipment  used  in  manufacturing  the  chair  cannot  be  deter- 
mined with  any  measuring  de\-ice.  It  must  be  estimated.  Con- 
sequently the  total  depreciation  of  equipment  is  distributed  over  all 
units  of  product  (chairs)  made.  Any  charging,  therefore,  which 
reduces  the  distributable  costs,  thereby  increases  automatically  the 


BUDGETARY  CONTROL 


accuracy  cf  the  cost  records.  The  growing  observance  of  the  princi- 
ple of  direct — that  is  to  say  correct — charging  has  done  much  to 
improve  the  exactness  of  cost  accounting.^ 

It  is  the  purpose  of  the  present  chapter  to  treat  under 
the  heading  of  "  manufacturing  expenses  "  the  items  termed 
"indirect  costs"  in  the  foregoing  quotation.  "Indirect 
expenses,"  "burden,"  and  "overhead"  are  other  terms  by 
which  these  expenses  are  known. 

Components  of  Manufacturing  Expense 

The  items  which  compose  manufacturing  expense  will 
vary  in  different  businesses,  depending  on  the  nature  of 
their  operations.  The  following  are  those  which  appear  in 
most  cases: 

1.  Indirect  material  8.  Maintenance 

2.  Supplies  9.  Depreciation 

3.  Indirect  labor  10.  Power 

4.  Supervision  11.  Heat  and  light 

5.  Inspection  12.  Small  tools 

6.  Experimental  work  13.  Taxes 

7.  Repairs  14.  Insurance 

The  foregoing  items  are  sufficient  to  indicate  the  nature 
of  those  which  generally  compose  manufacturing  expense. 
The  reader  can  probably  supply  other  items  of  manufactur- 
ing expense  from  his  experience.  Some  accountants  would 
combine  such  items  as  "indirect  labor,"  "supervision,"  and 
"inspection."  From  the  viewpoint  of  estimating  their 
amount,  it  is  desirable  to  have  them  separate. 

Classification  of  Manufacturing  Expense 

It  is  usually  desirable  that  manufacturing  expense  be 
classified  by  departments  and  that  subclassifications  be 
maintained  for  each  department.    Detailed  departmental 

*  Jordan  and  Harris,  Cost  Accounting,  page  23. 


THE  MANUFACTURING  EXPENSE  BUDGET 


191 


classifications  are  necessary  as  a  basis  for  effective  control. 
The  departmental  classification  makes  possible  the  fixing 
of  responsibility,  and  the  classification  within  the  depart- 
ment makes  possible  the  meeting  of  the  responsibility.  It 
also  affords  a  more  comprehensive  basis  for  judging  the 
success  with  which  the  responsibility  has  been  met. 

To  illustrate  concretely,  the  X  INI anufactu ring  Company 
has  four  departments  and  manufactures  one  commodity. 
In  1918  the  unit  cost  of  the  commodity  was  $12,  while  in 
1 91 9  it  was  $15.  In  attempting  to  find  the  cause  of  the 
increase,  the  first  analysis  will  be  to  determine  how  much 
of  the  total  cost  is  material  cost,  how  much  is  labor  cost, 
and  how  much  is  manufacturing  expense.  This  analysis 
shows  that  the  manufacturing  expense  per  unit  was  $3  in 
1918,  and  $4  in  1919.  An  analysis  of  the  cost  of  manu- 
facturing expense  by  departments  for  the  two  years  shows 
the  following: 


This  analysis  shows  that  the  principal  increases  in 
manufacturing  expenses  are  in  Departments  A  and  D. 
The  responsibility  for  the  increase  is  fixed  on  specific  de- 
partments, but  it  is  now  necessary  to  determine  whether 
the  increase  is  due  to  inefficiency  of  the  departmental  heads 
or  to  causes  over  which  they  had  no  control.  To  ascertain 
this,  it  is  necessary  to  examine  the  analysis  provided  by 
the  departmental  accounts. 

This  examination  shows  that  in  Departments  A  and  D 
a  large  amount  of  miscellaneous  supplies  and  indirect  labor 
is  necessary.  Owing  to  the  increase  in  the  price  of  supplies 
and  labor  during  the  year  191 9,  the  manufacturing  expense 
of  these  departments  was  increased.    If  it  is  shown  that 


Year 


Dept.  A     Dept.  B     Dept.  C     Dept.  D 
$.80        $.90  $.60  $.70 

1.20  .95  .65  1.20 


1918 
1919 


192 


BUDGETARY  CONTROL 


approximately  the  same  quantity  of  supplies  and  labor  was 
used  as  previously  but  its  price  had  greatly  increased,  the 
departmental  foreman  cannot  be  held  responsible.  If,  on 
the  other  hand,  it  is  found  that  the  increase  in  manufactur- 
ing expense  in  these  departments  was  due  to  the  use  of  an 
increased  quantity  of  supplies  and  labor  per  unit  of  product, 
there  is  then  circumstantial  evidence  of  inefficiency  on  the 
part  of  the  departmental  foreman,  and  he  should  be  re- 
quired to  show  cause  for  the  condition.  This  simple 
illustration  serves  to  show  the  necessity  for  a  detailed 
analysis  of  the  expenses  of  each  major  group  if  responsi- 
bility is  to  be  fixed  and  variations  explained. 

A  proper  classification  of  expenses  is  of  importance  both 
from  the  viewpoint  of  accounting  records  and  budget  reports. 

Determination  of  Manufacturing  Expense  Requirements 

The  estimate  of  manufacturing  expense,  like  the  esti- 
mate of  materials  and  of  labor,  is  based  on  the  estimate  of 
production.  It  is  somewhat  more  difficult  to  correlate  the 
manufacturing  expenses  with  the  production,  than  it  is  to 
correlate  materials  and  labor  with  production.  This  is 
due  to  two  reasons: 

I.  The  various  items  which  go  to  make  up  the  manu- 
facturing expenses  are  secured  from  various  sources  and 
their  procurement  is  not  centralized  under  one  individual, 
like  materials  and  labor.  For  instance,  the  indirect  mate- 
rial is  obtained  by  the  purchasing  agent,  the  indirect  labor 
by  the  personnel  department,  the  taxes  are  paid  by  the 
treasurer,  the  repairs  made  by  the  maintenance  depart- 
ment, and  so  on.  This  lack  of  centralized  responsibility 
makes  it  difficult  to  fix  the  duty  for  the  preparation  of  the 
manufacturing  expense  budget  on  those  who  are  responsible 
for  the  expenditures  which  result  in  the  procurement  cf  the 
"services"  of  which  it  is  composed. 


THE  MANUFACTURING  EXPENSE  BUDGET 


193 


2.  Manufacturing  expenses  do  not  vary  as  a  rule  in 
proportion  to  the  variation  in  production.  Usually  they 
do  not  increase  or  decrease  as  rapidly  as  production.  This 
is  due  to  the  fact  that  there  are  "fixed"  charges  which 
are  affected  little  if  at  all  by  the  volume  of  production. 
For  instance,  taxes  and  insurance  on  machinery  will  be 
the  same  whether  the  machine  is  run  at  full  or  half  capacity. 
There  are  other  charges  such  as  depreciation  and  supervi- 
sion which  will  be  affected  by  the  volume  of  production 
but  not  in  proportion.  If  production  is  sufficient  to  em- 
ploy ten  men  in  a  department,  it  is  necessary  to  have  a 
foreman,  and  the  same  foreman  may  be  able  to  supervise 
properly  twenty  men  when  production  increases  to  the 
point  where  they  are  needed.  Because  of  this  condition 
it  is  impossible  to  estimate  manufacturing  expenses  in  lump 
by  means  of  the  ratio  between  manufacturing  expense  and 
production,  if  the  production  varies  from  one  budget  period 
to  another. 

The  cost  accounting  department  is  the  one  place  where 
all  the  items  of  manufacturing  expense  are  shown.  Its 
records  show  what  the  manufacturing  expenses  of  the 
past  periods  have  been  and  it  is  possible  for  it  to  prepare 
on  the  basis  of  these  records  an  estimate  of  what  the  manu- 
facturing expenses  will  be.  The  estimate,  of  course,  must 
take  into  consideration  the  production  program  for  the 
period  as  shown  by  the  estimate  of  production.  To  do  this 
properly  the  cost  department  should  classify  the  manu- 
facturing expenses  as  "fixed"  and  "variable."  These 
terms  must  be  used  with  caution,  for  there  are  few  if  any 
expenses  which  may  be  literally  termed  as  "fixed."  If 
this  classification  is  made,  it  will  not  be  difficult  to  estimate 
the  fixed  charges,  but  very  careful  attention  must  be  given 
to  the  effect  of  the  production  volume  on  the  variable 
charges. 

13 


194 


BUDGETARY  CONTROL 


It  tends  to  simplicity  and  economy  to  have  the  estimate 
of  manufacturing  expense  prepared  by  the  cost  accounting 
department.  The  chief  objection  to  this  procedure  is  that 
this  department  is  apt  to  place  too  much  emphasis  on  the 
statistics  of  past  performance  and  too  little  emphasis  on 
the  contemplated  performance.  One  method  of  correcting 
this  difficulty  is  to  have  the  cost  department  classify  its 
estimate  so  as  to  show  the  expenses  to  be  incurred  by  each 
unit  or  department,  and  then  have  each  unit  or  department 
approve  that  part  of  the  estimate  for  which  it  is  responsible. 
For  instance,  the  purchasing  department  could  approve  the 
estimate  on  indirect  materials,  the  personnel  department 
the  estimate  on  indirect  labor,  the  treasurer  the  estimate  on 
taxes  and  insurance,  and  so  on. 

It  is,  of  course,  possible  to  have  each  separate  unit  or 
department  make  an  estimate  of  that  part  of  the  manu- 
facturing expense  for  which  it  is  responsible,  and  then 
have  these  combined  to  make  up  the  complete  estimate. 
The  separate  estimates  may  be  checked  against  the  ac- 
counting records  to  test  their  accuracy.  This  method 
requires  a  great  amount  of  care  in  getting  the  necessary 
information  needed  by  each  department  for  making  its 
estimate  and  in  seeing  to  it  that  each  prepares  the  estimate 
properly.  When  it  is  possible  to  do  so,  there  are  decided 
advantages  in  having  the  estimate  of  manufacturing  ex- 
pense prepared  by  the  staff  of  the  production  department, 
since  this  department  is  responsible  for  its  enforcement. 
The  only  disadvantage  of  this  procedure  is  that  this 
department  often  does  not  have  the  data  to  make  possible 
the  preparation  of  an  accurate  estimate. 

Distribution  of  Manufacturing  Expenses 

One  of  the  most  difficult  problems  with  which  engineers 
and  accountants  have  had  to  deal  in  the  attempt  to  as- 


THE  MANUFACTURING  EXPENSE  BUDGET  195 


certain  costs  of  manufactured  product,  is  the  allocation  of 
the  manufacturing  expenses  to  the  various  classes  or  units 
of  product.    This  problem  gives  rise  to  two  questions: 

1.  What  expenses  should  be  allocated  to  the  product? 

2.  What  method  should  be  employed  in  allocating  these  expenses? 

For  many  years  accountants  as  a  whole  assumed  that 
all  manufacturing  expenses  should  be  allocated  to  the 
product  and  therefore  gave  their  undivided  attention  to  the 
answering  of  the  second  question. 

A  number  of  methods  of  allocating  manufacturing  ex- 
penses were  developed.  These  ranged  from  the  simple 
method  of  using  a  percentage  on  direct  labor  cost,  to  the 
complex  method  of  using  a  machine  rate  plus  the  "supple- 
mentary" rate.  The  reader  is  doubtless  familiar  with 
these  various  methods  since  they  have  been  well  explained 
in  many  texts  on  cost  accounting  and  articles  in  magazines.^ 

The  purpose  of  all  these  methods  as  originally  developed 
is  to  allocate  as  accurately  as  possible  all  the  manufacturing 
expenses  of  a  period  to  the  goods  produced  during  that 
period.  During  recent  years  engineers  and  accountants 
have  come  to  realize  that  it  may  not  be  desirable  to  allocate 
all  the  manufacturing  expenses  to  the  product  produced. 
No  doubt  they  were  first  led  to  see  this  by  the  fact  that  if 
all  expenses  during  a  period  of  depression  are  charged  to 
the  product  produced  during  that  period,  the  cost  of  the 
product  is  exorbitant.  It  is  easy  to  see  that  if  a  plant  is 
running  at  60  per  cent  capacity  and  all  the  fixed  charges 
of  the  plant  are  allocated  against  the  60  per  cent  of  normal 
production,  the  costs  will  be  greatly  increased.  If  these 
costs  are  used  as  a  basis  for  establishing  sales  prices,  the 

'  Those  readers  who  may  desire  a  discussion  of  the  various  methods  of  distributing  overhead 
may  well  read  one  or  more  of  th;^  following:  Jordan  and  Harris,  Cost  Accounting;  Nicholson 
and  Rohrbach,  Cost  Accounting;  Scoville,  Cost  Accounting  and  Burden  Application;  Eggleston 
and  Robinson,  Business  Costs;  Church,  Manufacturing  Accounts  and  Costs. 


196 


BUDGETARY  CONTROL 


competitors  are  very  apt  to  get  the  business;  and  as  sales 
fall  off  there  will  be  a  further  decrease  in  production  with  a 
further  increase  in  cost,  with  the  consequent  increase  in 
sales  price,  which  results  in  a  decrease  in  sales,  and  so  on 
around  the  circle. 

Faced  by  this  situation,  accountants  and  engineers  real- 
ized the  necessity  of  developing  some  method  of  handling 
manufacturing  expenses  which  would  prevent  the  charging 
to  product  of  expenses  which  were  not  the  result  of  the 
production  of  this  product.  To  this  end,  predetermined  or 
standard  rates  were  established  by  which  the  product  was 
charged  only  with  the  same  amount  of  expenses  which  it 
would  have  been  charged  if  the  plant  was  running  at  its 
normal  capacity.  In  the  establishment  of  normal  capacity 
the  production  of  past  years  when  the  plant  was  operating 
under  what  was  thought  to  be  normal  conditions  was  taken 
as  a  basis.  The  manufacturing  expense  not  absorbed  by 
the  standard  rates  was  charged  direct  to  the  profit  and  loss 
account.  Those  who  are  interested  in  the  historical  de- 
velopment of  the  use  of  the  standard  rate  will  be  interested 
in  reading  pages  397-399,  "Cost  Accounting,"  by  Jordan 
and  Harris. 

Relation  of  Standard  Rates  to  Manufacturing  Expense  Budget 

From  the  viewpoint  of  administration,  the  importance 
of  the  standard  rates  for  manufacturing  expense  is  obvious. 
These  standard  rates  may  also  be  of  considerable  significance 
from  the  viewpoint  of  budgetary  control.  It  has  been 
pointed  out  in  the  discussion  of  materials  and  labor,  that 
if  standard  rates  have  been  set,  it  is  only  necessary  to 
multiply  these  by  the  quantity  of  finished  goods  called 
for  by  the  production  budget  to  obtain  the  estimate  of 
materials  or  estimate  of  labor.  If  standard  expense  rates 
have  been  set,  a  similar  procedure  may  be  followed  in  pre- 


THE  MANUFACTURING  EXPENSE  BUDGET 


197 


paring  the  estimate  of  manufacturing  expense.  The 
standard  expense  rate  for  each  product  may  be  multiplied 
by  the  quantity  of  this  product  called  for  in  the  production 
budget  in  order  to  obtain  the  estimated  manufacturing 
expense.  If  the  product  passes  through  two  or  more  de- 
partments, it  will  probably  be  necessary  to  use  a  different 
rate  for  each  department.  It  is  obvious  that  the  actual 
expenses  may  be  greater  or  less  than  the  standard,  and  this 
variation  must  be  given  consideration  in  preparing  the 
estimated  statement  of  profit  and  loss  and  the  financial 
budget. 

One  objection  to  this  method  from  the  viewpoint  of 
administrative  control,  is  that  if  the  production  varies  in 
quantity,  the  standard  rate  should  be  made  to  vary  also. 
In  the  establishment  of  standard  costs  it  has  been  the 
practice  of  accountants  to  select  one  or  more  periods  during 
which  they  think  there  has  been  normal  production,  and 
use  the  costs  of  these  periods  as  standard  costs,  or  at  least 
to  regard  the  production  of  these  periods  as  standard  pro- 
duction and  determine  the  standard  costs  on  the  basis  of 
the  quantity  of  production.  For  the  purpose  of  distribut- 
ing the  costs  of  production  evenly  over  all  periods  and 
thereby  determining  a  uniform  cost,  there  is  decided  merit 
in  this  method.  It  would  seem,  howe\^er,  from  the  view- 
point of  administrative  control,  that  it  would  be  much 
more  accurate  to  have  the  standard  costs  based  on  the 
anticipated  production  of  the  period  under  consideration. 

The  manufacturer  does  not  care  so  much  to  know  how 
his  costs  compare  with  what  they  should  be  if  he  produced 
the  quantity  which  he  produced  during  some  previous 
period,  as  he  desires  to  know: 

I.  At  the  beginning  of  the  period,  what  his  costs  will  be  if  he 
manufactures  what  he  plans  to  manufacture  during  the 
period. 


198 


BUDGETARY  CONTROL 


2.  During  the  period,  how  his  actual  costs  compare  with  what  he 

estimated  they  would  be. 

3.  At  the  end  of  the  period,  why  there  is  a  variation  between  the 

estimated  and  the  actual,  if  such  a  variation  exists. 

It  is  not  intended  to  imply  that  the  use  of  standard  rates 
as  a  means  of  equalizing  costs  may  not  be  desirable,  but 
only  to  emphasize  that  standard  costs  based  on  past  pro- 
duction may  not  give  the  manufacturer  the  information 
he  most  needs  in  judging  the  desirability  of  contemplated 
plans  or  of  controlling  these  plans  after  they  are  put  into 
operation. 

Relation  of  Budget  Program  to  Standard  Rates 

If  the  manufacturing  expenses  are  allocated  by  means 
of  the  "machine  rate,"  the  estimated  activity  of  the  plant 
can  be  given  effect  in  the  establishment  of  the  standard 
machine  rates.  Mr.  E.  O.  Sommer  in  Industrial  Manage- 
ment, January,  1920,  discusses  one  method  by  which  this  is 
done  in  the  following  quotation: 

The  object  in  establishing  a  machine  hour  rate  is  to  determine 
the  cost  of  running  a  machine  one  hour.    This  can  be  done  by: 

1.  Classifying  and  dividing  the  machines  into  units  of  like  opera- 

tion. 

2.  Estimating  the  percentage  of  activity  at  which  the  plant  is 

expected  to  operate. 

3.  Determining  the  operating  expenses  of  each  unit  for  a  given 

period. 

In  classifying  machines,  the  department  may  be  taken  as  a  unit 
if  all  the  machines  perform  the  same  operation;  should,  however,  the 
department  include  machines  of  unlike  operation,  we  shall  have  to 
go  a  step  further  and  subdivide  the  department  into  various 
machine  groups,  each  machine  in  a  group  perfonning  the  same 
operation.  This  subdivision  may  lead  us  so  far  as  to  consider  a 
single  machine  as  a  unit. 

Thus,  having  classified  the  processing  machines  of  the  plant 
into  units,  our  concern  is  to  collect  all  expenses  which  will  be  incurred 


THE  MANUFACTURING  EXPENSE  BUDGET 


199 


in  the  operation  of  these  individual  units  during  a  given  period. 
These  expenses  we  may  place  into  two  main  groups: 

1.  Comprising  such  items  as  can  be  directly  charged  against 

certain  units,  as  labor,  floor  space,  current  repairs,  etc., 
necessary  for  the  operation  of  that  unit. 

2.  Representing  indirect  expenses,   which  although  they  are 

largely  direct  charges  against  the  department,  still  cannot  be 
allocated  to  individual  units,  but  are  to  be  prorated  on  a  suit- 
able basis. 

The  percentage  of  activity,  the  third  factor  in  the  calculation 
of  predetermined  rates,  must  be  estimated  with  utmost  care.  If 
we  could  assume  that  the  plant  will  be  able  to  work  at  and  maintain 
a  100  per  cent  activity,  our  task  of  calculating  an  hourly  rate  would 
be  a  simple  one.  We  would  obviously  divide  the  total  working 
hours  of  the  week,  or  month,  or  year,  into  the  total  operating  cost 
for  that  period  and  arrive  at  a  cost  per  hour. 

Since,  however,  an  activity  of  100  per  cent  can  hardly  be  realized, 
a  method  must  be  found  to  ascertain  the  highest  possible  percentage 
of  activity  (budget  activity)  at  which  the  management  may  expect 
to  keep  the  plant  working. 

Should  the  statement  reveal  that  the  plant  will  not  be  kept 
operating  at  full  capacity  it  will  be  the  problem  of  the  management 
to  investigate  the  cause  of  this  condition  and  to  find  a  way  to  bring 
the  activity  to  a  normal  level.  Overequipment,  decrease  in  the 
demand  for  the  product,  or  competition  may  account  for  reduced 
activity. 

Many  expenses,  as  rent,  depreciation,  etc.,  accrue  as  time  goes 
on  whether  the  machine  be  active  or  idle,  and  the  cost  per  hour  will 
naturally  increase  in  the  same  proportion  as  the  activity  decreases. 
To  illustrate  this,  let  us  assume  that  these  fixed  overhead  expenses 
for  a  group  of  machines  be  $2,400  per  year.  Taking  the  year  at  50 
weeks  of  48  hours  each,  or  2,400  working  hours,  the  overhead  would 
be,  at  100  per  cent  activity,  $2,400  for  2,400  hours — $1  per  hour;  at 
90  per  cent  activity,  $2,400  for  2,160  hours — $1.1 1  per  hour;  at  85 
per  cent  activity,  $2,400  for  2,040  hours — $1.18  per  hour. 

Should  the  budget  activity  for  the  ensuing  period  be  90  per  cent, 
it  would  be  a  serious  error  to  distribute  the  operation  cost  on  a 
basis  of  100  per  cent  activity. 

Assume  for  example  that  the  budget  rate  has  been  based  on  a 


200 


BUDGETARY  CONTROL 


90  per  cent  activity  and  assume  further  that  the  actual  activity 
during  a  period  be  90  per  cent,  all  expenses  then  will  be  gradually 
charged  to  the  process,  and  the  debit  and  credit  side  of  the  operating 
account  of  this  particular  machine  group  will  be  in  balance. 

Should,  however,  the  actual  acti\  ity  fall  below  the  percentage 
used  in  the  calculation  of  the  machine  rate  (budget  rate),  there  would 
remain  in  the  operating  account  a  balance  of  undistributed  ex- 
penses. This  balance,  w^hich  is  due  to  curtailed  production, 
should  not  be  debited  to  the  production  account  either  directly  or 
by  increasing  the  budget  rate,  but  be  charged  to  profits.  Any 
increase  over  the  budget  activity  would  result  in  a  credit  balance 
on  the  operation  account  and  be  a  credit  to  profit  and  loss. 

If  a  comparison  of  the  actual  and  budget  figures  of  the  individual 
cost  factors  should  reveal  that  a  fluctuation  is  due  to  change  in 
prices,  a  revision  of  the  budget  will  be  necessary  and  a  new  rate 
must  be  determined. 

A  difference  between  the  actual  and  budget  activity  would 
indicate  either  an  increase  or  decrease  in  the  production.  Since  a 
loss  or  gain  due  to  fluctuations  in  the  activity  does  not  result  from 
the  manner  of  operating  a  unit,  any  difference  due  to  this  cause 
should  be  eliminated  from  the  operation  account. 

This  can  be  accomplished  best  by  calculating  an  "idle  time" 
and  "overtime"  rate,  which  will  represent  the  hourly  cost  of  all 
those  charges  which  are  incurred  regardless  of  whether  the  machine 
group  is  active  or  idle.  We  shall  credit  the  operation  account  at 
the  "idle  time"  rate  for  the  total  idle  hours  in  the  budget  period, 
and  charge  an  account  called  "  Idle  and  Overtime."  Inversely,  we 
shall  debit  the  operation  on  account  at  the  "overtime"  rate  for 
the  total  active  hours  in  excess  of  the  budget  hours,  and  credit  the 
"Idle  and  Overtime"  account.  A  balance,  left  in  this  account  at 
the  end  of  the  budget  period,  which  will  then  either  show  a  loss  due 
to  curtailed  production  or  a  gain  due  to  increased  activity,  is  closed 
into  the  sales  account. 

The  author  does  not  intend  to  endorse  the  general 
application  of  the  particular  method  described  in  this 
quotation,  but  the  general  principle  it  illustrates,  that 
standard  rates  should  be  related  to  the  budget  program,  is 
worth  Emphasis. 


THE  MANUFACTURING  EXPENSE  BUDGET  201 


Relation  of  Standard  Rates  to  Volume  of  Production 

It  should  of  course  be  understood  that  in  the  setting  of 
standard  rates  based  on  estimated  activity  as  explained  in 
the  foregoing  quotation,  only  the  expenses  which  are  prop- 
erly applicable  to  the  estimated  production  should  be 
included. 

To  accomplish  this  end  the  following  procedure  is  neces- 
sary: 

1.  Determine  the  "normal"  production  of  the  plant.    This  of 

course  cannot  be  established  with  exactness.  Generally  speak- 
ing, the  normal  production  is  that  which  would  be  accomplished 
if  the  plant  was  operating  so  that  the  equipment  as  a  whole 
would  be  used  at  the  greatest  efficiency,  at  which  it  can  reasoft- 
ably  he  expected  to  be  used.  Normal  production  is  usually 
less  than  the  maxitmcm  production.  In  determining  normal 
production,  all  parts  of  the  equipment  must  be  given  careful 
consideration.  The  old  adage  that  "a  chain  is  no  stronger 
than  its  weakest  link"  is  approximately  true  of  the  equipment 
of  a  plant.  For  instance,  the  melting  department  of  a  foundry 
may  be  able  to  turn  out  sufficient  melt  to  produce  loo  tons 
of  castings  during  a  certain  period,  but  if  the  moulding  floor 
is  only  large  enough  to  make  possible  the  moulding  of  75  tons, 
the  normal  capacity  of  foundry  cannot  exceed  75  tons. 

2.  Determine  the  manufacturing  expenses  which  would  be  incurred 

if  the  factory  operated  at  normal  capacity. 

3.  Determine  the  estimated  production  under  the  budget  program 

for  the  current  period. 

4.  Determine  the  ratio  of  (3)  to  (i)  and  apply  this  ratio  to  (2),  t;) 

obtain  the  manufacturing  expenses  applicable  to  the  current 
period.  Judgment  will  have  to  be  used  in  doing  this  because 
of  the  changing  price  level  and  other  factorswhich  may  necessi- 
tate modifications  of  this  mathematical  result. 

5.  On  the  basis  of  the  result  obtained  in  (4)  and  the  estimated 

activity  of  the  current  period,  establish  standard  machine  rates. 
There  is  a  difference  of  opinion  as  to  what  should  be  included 
in  the  establishment  of  machine  rates.  It  is  not  worth  while 
to  enter  into  this  discussion  here. 


202 


BUDGETARY  CONTROL 


Modification  of  the  Standard  Machine  Rate  Plan 

The  author  fully  realizes  that  there  are  many  businesses 
which  will  find  it  impracticable  to  follow  the  plan  for  estab- 
lishing standard  expense  rates  which  has  been  outlined  in 
the  foregoing  discussion.  Many  manufacturing  firms  do 
not  find  it  expedient  to  establish  machine  rates  at  all. 
Nevertheless  the  general  principles  developed  by  the  fore- 
going are  applicable  to  all  manufacturing  firms,  namely: 

1.  That  the  product  of  each  period  should  be  charged  only  with 

the  manufacturing  expenses  which  contribute  to  its  production, 
and  should  not  be  burdened  with  the  expenses  arising  from 
unused  cai:)acity  or  idle  time. 

2.  That  a  standard  rate  for  charging  the  expense  to  the  product 

should  be  established  and  that  the  undistributed  burden  should 
be  charged  directly  to  profit  and  loss.  In  case  of  production 
above  the  normal,  the  excess  should  be  credited  to  profit  and 
loss. 

These  principles  can  be  applied  regardless  of  the  method 
employed  in  the  distribution  of  manufacturing  expenses. 

The  "Miscellaneous"  Expense  Budget 

In  the  discussion  of  the  materials  budget  it  was  explained 
that  some  businesses  prepare  a  "stores"  budget  which  in- 
cludes both  direct  and  indirect  material,  and  in  the  discussion 
of  the  labor  budget  it  has  been  explained  that  sometimes  a 
"pay-roll"  budget  is  prepared  which  includes  both  direct 
and  indirect  labor.  When  this  procedure  is  followed,  two 
of  the  large  items  of  manufacturing  expense  are  eliminated 
from  the  manufacturing  expense  budget.  In  this  case 
there  may  be  prepared  a  "miscellaneous"  expense  budget 
which  will  include  all  the  expenses  other  than  indirect  labor 
and  indirect  material. 

It  is  easier  to  prepare  the  miscellaneous  expense  budget 
and  to  have  the  indirect  materials  and  labor  included  in  the 


THE  MANUFACTURING  EXPENSE  BUDGET  203 

stores  and  pay-roll  budget  respectively.  But  it  is  doubtful 
if  this  method  gives  as  effective  control  of  manufacturing 
expenses.  It  is  desirable  that  all  manufacturing  expense 
be  shown  as  a  total  and  that  standards  be  set  up  by  which 
to  judge  its  amount.  It  is  of  course  possible  to  set  up  these 
standards  independent  of  the  budgets,  but  it  is  much  more 
effective  if  they  are  correlated  so  that  each  will  check  the 
other.  It  is  emphasized  throughout  this  book  that  the 
budgets  should  be  prepared  in  terms  of  "units  of  responsi- 
bility." The  production  department  is  responsible  for  all 
the  manufacturing  expense  and  it  is  better  that  its  total 
amount  be  shown  in  one  budget — the  manufacturing  expense 
budget. 

It  is  admitted  that  this  procedure  necessitates  the 
purchasing  agent  to  make  up  an  estimate  of  purchases  for 
the  indirect  materials  included  in  the  manufacturing  expense 
budget.  Obviously  the  purchases  of  these  materials  will 
not  correspond  with  their  consumption,  and  it  is  the  latter 
which  is  shown  on  the  manufacturing  expense  budget.  In 
some  cases  the  purchasing  agent  may  find  it  necessary,  in 
order  to  secure  an  economical  purchase,  to  buy  at  one 
time  sufficient  to  last  for  a  considerable  number  of 
periods. 

For  the  purpose  of  the  financial  budget  it  is  the  disburse- 
ments which  are  desired,  but  for  the  purpose  of  the  esti- 
mated balance  sheet  and  estimated  statement  of  profit  and 
loss  the  consumption  is  necessary.  It  is  thought  best, 
therefore,  to  have  the  composite  budget  for  manufacturing 
expenses  prepared,  and  to  support  this  with  the  estimate  of 
purchases  with  the  consequent  disbursements. 

Preparation  of  the  Manufacturing  Expense  Budget 

The  method  of  preparing  this  budget  has  been  indicated 
by  the  preceding  discussion.    If  it  is  assumed  that  the 


204 


BUDGETARY  CONTROL 


original  estimate  of  manufacturing  expense  is  prepared  by 
the  cost  accounting  department,  a  copy  of  it  will  be  sent 
by  this  department  to  each  department  responsible  for 
incurring  expenditures  under  it.  Each  of  these  depart- 
ments will  indicate  any  changes  which  it  thinks  necessary, 
and  return  the  estimate  with  its  approval  to  the  cost  de- 
partment. The  purchasing  agent  will  attach  to  the  esti- 
mate of  the  cost  department  an  estimate  of  purchases  of 
materials  which  are  necessary  to  supply  the  indirect  mate- 
rials called  for  by  the  program. 

The  cost  accounting  department  will  prepare  an  esti- 
mate for  submission  to  the  executive  in  charge  of  budgetary 
procedure.  On  this  estimate  it  will  give  effect  to  the 
revisions  which  have  been  made  by  the  various  depart- 
ments. If  it  does  not  approve  of  these  revisions,  it  will 
show  both  its  estimates  and  the  revisions,  and  make  such 
comments  as  it  thinks  appropriate. 

If  the  original  estimate  is  prepared  by  the  production 
department,  it  will  follow  the  same  procedure  as  outlined 
above  for  the  cost  department.  As  previously  explained, 
it  is  desirable  that  the  estimate  be  prepared  by  the  produc- 
tion staff,  but  it  is  more  frequently  prepared  by  the  cost 
department. 

The  executive  in  charge  of  budgetary  procedure  will 
transmit  the  estimate  received  from  the  cost  accounting 
department  or  the  production  department  to  the  budget 
committee.  He  may  accompany  it  with  such  comments 
as  he  thinks  appropriate.  The  budget  committee  will 
consider  the  estimate  of  manufacturing  expense  in  con- 
nection with  all  the  other  estimates  which  it  receives  at  the 
same  time,  and  will  make  any  revisions  it  deems  necessary. 
It  will  transmit  the  estimate  as  approved  to  the  executive 
in  charge  of  the  budget  procedure,  who  will  transfer  a  copy 
of  it  to  each  of  the  departments  which  are  interested  in  its 


206 


BUDGETARY  CONTROL 


enforcement.  In  form  the  manufacturing  expense  budget 
may  be  made  as  shown  in  Figure  1 6. 

Control  of  Manufacturing  Expense  Budget 

The  cost  accounting  department  will  prepare  monthly 
reports  showing  a  comparison  between  the  actual  and 
estimated  manufacturing  expense.  This  report  may  be  in 
the  form  shown  in  Figure  17.  The  columnar  headings  on 
this  report  are  self-explanatory. 

This  report  will  be  submitted  to  the  executive  in  charge 
of  the  budget  procedure  and  will  be  transferred  by  him  to 
the  budget  committee.  The  committee  will  study  this 
report  in  connection  with  the  other  monthly  reports,  and 
will  make  any  revisions  in  the  manufacturing  expense  budget 
which  it  thinks  are  necessary  as  indicated  by  the  reports. 
Any  changes  it  makes  will  be  transmitted  to  the  departments 
concerned  by  the  executive  in  charge  of  the  budgetary 
procedure. 

In  addition  to  the  general  report  on  the  budget  as  a 
whole,  there  should  be  prepared  a  separate  report  for  each 
department  in  the  factory,  showing  a  comparison  between 
the  actual  and  standard  performance.  In  case  the  general 
report  shows  a  wide  variation  between  the  actual  and  the 
estimated  expenditures,  these  detailed  reports  will  provide 
information  which  the  executive  in  charge  of  the  budget 
procedure  can  use  in  explaining  these  variations  to  the 
budget  committee. 

Review  and  Summary  of  Production  Control 

In  Chapters  IX  to  XIII,  inclusive,  an  attempt  has 
been  made  to  outline  the  procedure  necessary  to  effect  a 
coordination  of  sales  and  production,  and  to  prepare  and 
execute  a  production  program.  Previously  in  Chapters 
V  and  VI  the  method  by  which  the  sales  requirements 


THE  MANUFACTURING  EXPENSE  BUDGET 


207 


are  determined  has  been  explained.  In  summary  form 
the  procedure  discussed  in  these  chapters  may  be  outlined 
as  follows: 


I.  Preparation  of  Sales  Budget 

1.  Estimates  prepared  by  sales  units. 

2.  Revised  by  general  sales  office. 

3.  Revised  by  the  production  department  in  the  light  of  production 

possibilities  and  desirabilities. 

4.  Revised  by  the  controller  or  other  officer  in  the  light  of  profit 

possibilities. 

5.  Forwarded  to  the  budget  committee  for  final  revision  and 

approval. 

II.  Preparation  of  "Production"  Budgets 

1.  Finished  Goods  Budget: 

(a)  Estimate  of  finished  goods  requirements  prepared  by  the 

production  department  from  the  sales  estimates. 

(b)  Revision  and  approval  of  finished  goods  estimates  by  the 

budget  committee. 

(c)  Enforcement  of  this  budget  through  the  means  of  the 

balance  of  stores  records  operated  under  maximum  and 
minimum  standards. 

2.  Materials  Budget: 

(a)  Estimate  of  materials  requirements  prepared  from  t\\i 

finished  goods  estimate  by  the  production  department 
(the  duty  of  preparing  this  estimate  is  usually  delegated 
by  the  head  of  the  production  department  to  the 
planning  department). 

(b)  Estimate  of  material  requirements,  after  approval  by 

the  head  of  the  production  department,  is  transmitted 
to  the  purchasing  department  and  this  department 
prepares  an  estimate  of  the  material  purchases  required 
and  the  disbursements  resulting  therefrom. 

(c)  Estimate  of  materials  and  purchases  revised  and  approved 

by  the  budget  commi  ttee. 

(d)  Enforcement  of  materials  budget  through  the  means  of 

the  materials  balance  of  stores  records  operated  under 
maximum  and  minimum  standards. 


208 


BUDGETARY  CONTROL 


3.  Labor  Budget: 

(a)  Estimate  of  labor  requirements  prepared  from  the  finished 

goods  budget  by  the  production  department  (the  duty 
of  preparing  this  estimate  is  usually  delegated  by  the 
head  of  the  production  department  to  the  planning 
department). 

(b)  Estimate  of  labor  requirements,  after  approval  by  the 

head  of  the  production  department,  is  transmitted  to 
the  personnel  department  and  this  department  makes 
an  estimate  of  the  cost  of  supplying  this  labor. 

(c)  Estimate  of  labor  requirements  and  labor  cost  revised 

and  approved  by  the  budget  committee. 

(d)  Enforcement  of  the  labor  budget  by  the  production 

department  with  the  assistance  of  the  personnel  de- 
partment, through  the  agency  of  a  centralized  produc- 
tion control  system. 

4.  Manufacturing  Expense  Budget: 

(a)  Estimate  of  manufacturing  expense  requirements  made 

by  cost  accounting  department  or  production  depart- 
ment. 

(b)  Estimate  of  manufacturing  expense  requirements  ap- 

proved by  the  production  manager  and  the  head  of 
the  various  departments  responsible  for  the  incurrence 
of  the  expenditures  for  which  it  provides. 

(c)  Estimate  as  approved  in  (b)  transmitted  to  budget  com- 

mittee for  revision  and  approval. 

(d)  Enforcement  of  the  estimate  by  the  production  de- 

partment through  the  agency  of  a  centralized  control 
system. 

III.  Monthly  Reports  for  Control  and  Revision  of  Budgets 

1.  Report  on  finished  stock  budget  as  shown  in  Figure  8  (page  141 ). 

2.  Report  on  materials  budget  as  shown  in  Figure  11  (page  161). 

3.  Report  on  labor  budget  as  shown  in  Figure  13  (page  175). 

4.  Report  on  manufacturing  expense  budget  as  shown  in  Figure  17 
(page  205). 

IV.  Monthly  Revision  of  Budgets 

I .  Budget  committee  receives  monthly  reports  on  all  departmental 
estimates,  including  those  outlined  under  (III). 


THE  MANUFACTURING  EXPENSE  BUDGET  209 


2.  The  committee  considers  these  reports  with  reference  to  their 

relation  to  each  other  and  makes  such  revisions  as  are  deemed 
necessary. 

3.  Any  revisions  made  in  the  budgets  outhned  in  (II)  will  be  com- 

municated to  the  production  department  and  the  other  de- 
partments concerned. 

It  should  be  understood  that  the  procedure  given  in 
this  outline  is  intended  to  be  suggestive  and  not  arbitrary. 
Each  firm  must  adopt  a  procedure  to  fit  its  particular  needs. 
It  is  thought  that  if  the  foregoing  procedure  is  understood 
properly,  it  will  not  be  difficult  to  make  the  adaptations 
required  in  any  particular  case. 


14 


CHAPTER  XIV 


THE  PURCHASES  BUDGET 

Relation  of  Purchases  Budget  to  the  Sales  Budget 

In  the  preceding  chapters  considerable  attention  has 
been  given  to  the  method  by  which  the  manufacturer  plans 
'  a  production  program  which  will  result  in  a  proper  coordi- 
nation between  production  and  sales.  But  the  merchant 
has  a  similar  problem  of  coordination,  which  he  can  solve 
only  by  formulating  a  purchasing  program  which  will  per- 
form the  same  function  for  him  as  the  production  program 
performs  for  the  manufacturer. 

The  amount  of  goods  which  is  to  be  purchased  by  a 
merchant  is  determined  primarily  by  his  estimate  of  future 
sales.  Goods  are  purchased  only  to  be  sold,  and  sales  can 
be  consummated  only  when  goods  are  available  for  sale. 
The  general  manager  of  a  mercantile  store  is  charged  with  a 
double  responsibility.  He  must  maintain  such  stocks  of 
goods  as  will  enable  the  store  to  fill  customers'  orders,  and 
at  the  same  time  he  must  avoid  the  accumulation  of  stock 
beyond  the  sales  demands,  as  such  excessive  accumulation 
results  in  loss  from  tied  up  capital,  and  probably  also  from 
the  obsolescence  and  deterioration  of  the  merchandise. 

The  general  manager  can  meet  this  responsibility  only 
by  anticipating  sales  demands  and  setting  up  as  nearly  as 
possible  a  schedule  of  deliveries  to  stock  which  will  satisfy 
but  not  exceed  these  demands. 

In  merchandise  planning,  therefore,  the  first  step  is  the 
determining  of  the  amount  of  future  sales;  the  second  step 
is  the  determining  of  the  purchases  necessary  to  meet  these 
sales;  and  the  third  step  is  the  setting  up  of  a  purchasing 
program  which  will  coordinate  the  deliveries  of  purchases 

210 


THE  PURCHASES  BUDGET 


211 


with  the  sales  deliveries  required  by  the  sales  program. 
The  first  step  has  been  previously  discussed.  The  second 
and  third  will  be  dealt  with  in  this  chapter. 

Determination  of  Purchases  Requirements 

The  ideal  purchases  program,  from  the  viewpoint  of  the 
economical  use  of  capital,  would  be  one  which  provided  for 
the  delivery  to  stock  each  day  of  the  exact  amount  of  mer- 
chandise which  will  be  sold  that  day.  Such  a  program  is 
not  feasible  for  two  reasons: 

1.  In  a  mercantile  store,  it  is  necessary  to  ha\-e  some  merchandise 

on  hand  for  display  purposes.  The  customer  desires  an  assort- 
ment from  which  to  select  his  purchases.  This  necessitates  the 
keeping  on  hand  of  a  considerable  quantity  of  merchandise. 
The  amount  which  must  be  kept  is  dependent  on  the  extent  of 
the  sizes,  varieties,  and  grades  of  the  merchandise  which  is 
kept  for  sale. 

2.  It  is  impossible  to  estimate  sales  demands  or  to  plan  purchases 

deliveries  with  sufficient  accuracy  to  have  the  same  amount 
delivered  each  day  as  is  sold  on  that  day.  To  provide  against 
a  failure  to  meet  sales  demands  it  is  necessary  to  keep  a  cer- 
tain amount  of  merchandise  on  hand,  which  is  termed  the 
merchandise  inventory. 

The  principal  problem  in  merchandise  planning  is  to 
determine  the  size  of  the  inventory  which  should  be  main- 
tained, and  to  set  up  a  purchases  program  which  will  schedule 
deliveries  to  stock  in  such  quantities  and  at  such  times  as  to 
provide  for  its  maintenance  at  this  amount.  The  problem 
of  purchases  requirements  resolves  itself,  therefore,  into  a 
problem  of  finished  stock  requirements. 

The  problem  of  setting  up  an  estimate  of  finished  stock 
requirements  necessitates : 

1.  An  estimate  of  the  sales  that  will  be  made  of  each  kind  and  class 

of  goods.    This  estimate  is  pro\'ided  by  the  sales  program. 

2.  A  statement  of  the  inventory-  of  finished  goods  that  has  proved 

sufficient  in  meeting  the  sales  requirements  of  precedin-j  periods. 


212 


BUDGETARY  CONTROL 


This  information  is  used  as  a  basis  for  the  preparation  of 
an  estimate  of  the  finished  goods  inventory  requirements 
throughout  the  coming  selHng  period. 

Method  of  Determining  Inventory 

If  inventory  figures  are  to  be  available  for  prompt  use  in 
the  preparation  of  the  purchases  budget,  it  is  necessary  that 
a  definite  method  by  which  inventory  is  to  be  secured  be 
determined  and  the  appropriate  procedure  for  the  enforce- 
ment of  this  method  be  established. 

There  are  three  methods  in  current  use  by  which  inven- 
tories may  be  obtained.  These  will  be  discussed  under  the 
following  headings: 

1.  Perpetual  inventory 

2.  Estimated  inventory 

3.  Physical  inventory 

Perpetual  Inventory 

All  the  information  required  in  setting  up  a  system  of 
finished  goods  stock  requirements  is  contained  in  a  merchan- 
dise account  that  shows  the  quantities  of  each  merchandise 
item  received  at  cost  contra  to  the  amounts  of  the  item  sold, 
the  sales  being  also  computed  at  cost.  The  resulting  bal- 
ance shows  the  amount  of  each  item  of  merchandise  on  hand 
at  cost.  Such  a  merchandise  account  is  commonly  known 
as  a  perpetual  inventory. 

If  a  perpetual  inventory  is  maintained  on  the  goods  in 
stock,  it  will  show  the  cost  of  such  goods  as  they  are  shipped 
from  the  vendor,  and  will  also  show  the  value  at  cost  of 
goods  shipped  under  sales  invoices.  The  net  figures  in  such 
an  inventory  will  indicate  at  all  times  the  goods  on  hand. 

It  is  possible  to  keep  the  inventory  record  in  terms  of 
quantities  rather  than  in  terms  of  value,  if  desired.  A  form 
of  inventory  record  suitable  for  use  in  connection  with  raw 


THE  PURCHASES  BUDGET 


213 


materials  is  shown  in  Figure  9  (page  153).  The  record  for 
general  merchandise  is  usually  more  simple  than  this  form, 
but  the  same  principles  govern  its  construction  and  use. 

Estimated  Inventory 

The  experience  of  merchants  is  that  perpetual  inven- 
tories are  often  expensive  in  their  operation.  This  is  espe- 
cially true  where  many  small  items  are  bought  and  sold,  and 
where  the  average  turnover  of  the  stock  is  high.  Many  mer- 
chants content  themselves  with  estimated  inventories  of 
merchandise  on  hand,  and  these  estimates  are  proven  as  to 
their  accuracy  by  actual  inventory  once  or  twice  a  year. 

The  estimated  inventory  is  determined  on  the  basis  that 
the  actual  inventory  at  the  beginning  of  the  period,  plus 
purchases  for  the  period,  plus  the  estimated  gross  profit 
subtracted  from  the  sales  at  sales  price,  equals  the  ending 
inventory.  The  method  of  arriving  at  this  formula  will  be 
seen  easily  if  the  organization  of  the  trading  section  of  the 
pro  forma  statement  of  profit  and  loss  is  considered. 

It  may  be  assumed  that  the  trading  section  of  the  state- 
ment of  profit  and  loss  of  the  Brown  Mercantile  Company 
for  the  month  of  December  appears  as  follows : 


The  Brown  Mercantile  Company 
Statement  of  Profit  and  Loss 
For  Month  Ended  December  31,  192- 


Sales  

Inventory,  December  i 
Purchases  for  month .  . 


$51,000.00 


$16,500.00 
34,100 .00 


Total  Merchandise  in  Stockroom  during  month 
Inventory,  December  31  


$50,600 . 00 
13,200.00 


Cost  of  Goods  Sold 


37,400 .00 


Gross  Profit  on  Sales 


$13,600 .00 


214 


BUDGETARY  CONTROL 


From  the  foregoing  statement,  it  is  possible  to  prepare 
the  following  equation : 

Sales  —  Beginning  I  nventory  —  Purchases  +  Ending  I  nventory 
=  Gross  Profit 

Ordinarily  when  a  statement  of  profit  and  loss  is  made, 
the  only  unknown  quantity  is  the  gross  profit,  and  it  is 
obtained  by  this  equation.  When  it  is  desired  to  use  this 
formula  for  estimating  the  ending  inventory,  there  are  two 
unknown  quantities — the  ending  inventory  and  the  gross 
profit.  One  of  these  must  be  determined  before  the  equa- 
tion can  be  solved.  This  is  accomplished  by  estimating  the 
gross  profit.  To  make  the  estimate,  the  ratio  of  the  average 
gross  profit  to  sales  during  the  past  periods  is  determined, 
and  this  percentage  is  applied  to  the  sales  of  the  current 
period  to  obtain  the  estimated  gross  profit  for  this  period. 

To  illustrate,  it  is  found  that  the  average  gross  profit  of 
the  Brown  Mercantile  Company  during  the  past  three 
years  has  been  26.66  per  cent  of  sales.  It  is  thought  that 
the  average  gross  profit  of  these  years  is  indicative  of  the 
gross  profit  of  the  month  of  December  of  the  current  year. 
By  taking  this  percentage  of  the  sales  for  this  month,  the 
estimated  gross  profit  is  calculated  to  be  $13,600.  By  using 
this  figure,  the  equation  given  above  can  be  stated  as  follows: 

$5 1 ,000  —  $16,500  —  $34, 100 -h Ending  Inventory  =  $13,600 

By  transposition  and  solving,  the  ending  inventory  is  de- 
termined to  be  $13,200.  Since  the  gross  profits  on  dif- 
ferent lines  of  goods  varies,  it  is  necessary  to  perform  the 
foregoing  calculation  for  each  line  of  goods  if  an  accurate 
estimated  inventory  is  to  be  obtained. 

It  should  be  evident  that  estimated  inventories  can  be 
only  approximately  correct.  If  the  merchandise  manager 
has  before  him  only  estimated  inventories  as  at  the  close  of 


THE  PURCHASES  BUDGET 


215 


each  month  or  fiscal  period,  he  must  use  his  judgment  in 
basing  his  actions  on  them.  In  any  case  frequent  tests 
should  be  made  to  verify  the  accuracy  of  the  estimate. 

Physical  Inventories 

In  those  businesses  where  it  is  not  feasible  to  maintain  a 
perpetual  im'entory  because  of  the  cost  involved,  and  where 
it  is  impossible  to  obtain  an  accurate  estimated  inventory 
because  of  the  widely  var>dng  rates  of  gross  profit,  it  may 
be  necessary  to  resort  to  actual  inventories  taken  at  fre- 
quent intervals.  This  necessitates  the  taking  of  a  physical 
count  of  the  goods  on  hand. 

Some  department  stores  take  an  inventory'  in  certain 
departments  e\'ery  two  weeks.  Such  a  check-up  at  frequent 
interv^als  is  especially  desirable  in  the  case  of  variety  goods, 
where  fashion  and  styles  play  an  important  part.  Practi- 
cally all  businesses  take  a  physical  inventory  yearly,  and 
there  is  a  decided  tendency  towards  semiannual  and  quar- 
terly inventories.  It  has  been  found  that  if  a  standardized 
procedure  for'  the  taking  of  inventories  is  properly  worked 
out,  the  task  is  not  so  great  as  it  was  formerly  thought  to  be. 

Relation  of  Inventory  Planning  to  Statistics  of  Past  Periods 

In  estimating  inventory  requirements  it  is  necessary  to 
refer  to  the  statistics  of  previous  periods  as  showm  by  the 
accounting  records.  As  to  how  many  past  periods  should 
be  considered  will  depend  on  the  circumstances  of  each  case. 
The  statistics  desired  are  those  which  will  most  nearly  indi- 
cate the  probable  condition  of  the  current  year.  It  may  be 
that  conditions  have  changed  so  rapidly  that  it  is  deemed 
wise  to  use  only  the  statistics  available  for  the  preceding 
period,  or,  on  the  other  hand,  the  preceding  period  may  be 
considered  as  abnormal  and  may  be  disregarded  entirely. 

In  some  cases  a  weighted  average  of  three  or  more  past 


2l6 


BUDGETARY  CONTROL 


periods  is  taken.  In  any  case,  the  object  is  the  same — to 
obtain  the  statistics  with  reference  to  past  operations  which 
will  be  most  helpful  in  planning  future  operations.  For 
the  sake  of  brevity  in  the  following  discussion,  reference  will 
be  made  to  the  "past  period"  or  "past  periods"  without 
defining  the  length  of  this  period,  or  periods,  unless  such 
definition  is  necessary  to  make  the  meaning  of  the  discus- 
sion clear. 

Determination  of  "Normal"  Inventory 

In  the  preceding  discussion  it  has  been  explained  that 
the  next  step  in  merchandise  planning  after  the  sales  esti- 
mate is  prepared,  is  to  determine  the  "  average  "  or  "  normal " 
inventory  which  is  necessary  to  meet  sales  demands.  To 
accomplish  this  it  is  necessary : 

1.  To  determine  the  average  inventory  during  past  periods. 

2.  To  determine  the  ratio  of  the  average  inventory  of  past  periods 

to  the  sales  of  those  periods,  that  is,  determine  the  merchan- 
dise turnover  of  those  periods. 

3.  To  apply  the  turnover  of  past  periods  to  the  estimated  sales  of 

the  current  period  to  obtain  the  average  inventory  for  the 
present  period. 

Determination  of  Inventory  of  Past  Periods 

If  any  rational  control  has  been  exercised  over  stock 
investments  during  the  past  periods,  inventory  of  stock  on 
hand  must  have  been  taken  at  frequent  intervals.  This 
inventory  may  have  been  obtained  by  any  of  the  methods 
discussed  in  the  preceding  paragraphs. 

If  it  was  deemed  necessary  to  know  the  value  of  the 
stock  on  hand  only  at  the  beginning  and  the  end  of  the 
period  a  physical  inventory  may  have  been  taken.  If  it  was 
deemed  desirable  to  have  the  value  of  the  stock  on  hand 
at  more  frequent  intervals,  it  is  probable  that  either  an 
estimated  inventory  was  determined  at  regular  intervals  or 


THE  PURCHASES  BUDGET 


217 


stock  records  established  which  made  possible  a  perpetual 
or  continuous  inventory. 

It  is  apparent  that  the  more  frequently  the  inventory 
is  determined,  the  more  useful  are  the  statistics  obtained 
thereby  in  determining  average  inventory  and  in  planning 
stock  investment  control.  In  any  case  the  desire  for 
accuracy  must  be  balanced  against  practicability. 

Calculation  of  Turnover 

Whatever  method  of  taking  inventory  has  been  followed 
during  the  past  periods,  it  should  be  possible  to  determine 
at  least  approximately  the  average  inventory  and  the  ratio 
of  the  average  inventory  of  each  period  to  the  sales  for  the 
same  period.  In  other  words,  the  turnover  for  each  of  the 
past  periods  can  be  determined.  If  the  turnover  computa- 
tions are  to  be  of  value,  it  is  necessary  that  care  be  exercised 
to  calculate  them  properly. 

In  practice  it  will  be  found  that  several  methods  are  used  in  the 
determination  of  merchandise  turnover.  There  are  in  fact  but  two 
methods  of  determining  turnover  accurately.  They  are  as  follows: 
I.  Divide  the  cost  of  the  goods  sold  during  the  year  by  the  cost 
of  the  average  inventory  of  the  year.  For  instance,  a  retail  store 
carries  on  the  average  a  stock  of  goods  the  cost  price  of  which  is 
$20,000  and  makes  during  the  year  sales  of  $100,000  on  which  a  gross 
profit  of  twenty  per  cent  is  made.  The  cost  of  the  goods  sold  is  $80,- 
000  and  the  turnover  is  four. 

In  other  words,  in  this  store,  on  an  average,  the  articles  sold  re- 
main in  stock  three  months  after  they  are  purchased  before  they  are 
sold.  It  will,  of  course,  be  realized  that  it  is  rather  dangerous  to  try 
to  determine  the  average  turnover  on  all  goods  carried  in  stock.  It 
is  more  accurate  to  determine  if  possible  the  turnover  for  each  kind 
of  goods,  since  the  turnover  varies  on  each  kind. 

2.  The  turnover  may  be  determined  by  dividing  the  average  in- 
ventory for  the  year  at  sales  price  into  the  sales  at  sales  price.  For 
instance,  taking  the  illustration  given  above,  where  the  average  in- 
ventory at  cost  is  $20,000  and  the  sales  for  the  year  are  $100,000  on 
which  an  average  gross  profit  of  twenty  per  cent  is  made ;  if  the  inven- 


2l8 


BUDGETARY  CONTROL 


tory  is  taken  at  sales  price,  it  will  be  seen  that  it  will  amount  to 
$25,000,  and  dividing  the  sales  of  $100,000  by  $25,000,  a  turnover 
of  four  will  be  obtained. 

It  will  be  seen  that  the  same  result  is  obtained  as  in  the  first  case 
where  the  inventory  at  cost  is  divided  into  the  sales  at  cost.  Either 
method  can  be  used,  whichever  is  the  more  convenient. ^ 

The  error  is  sometimes  made  of  dividing  the  sales  at 
seUing  price  by  the  inventory  at  cost.  This  obviously  gives 
a  turnover  larger  than  the  actual  one. 

When  a  firm  relies  on  a  physical  inventory  taken  once  a 
year,  it  may  determine  its  average  inventory  by  taking  one- 
half  of  the  sum  of  the  beginning  and  ending  inventories.  If 
the  sales  of  the  business  are  subject  to  seasonal  fluctuations, 
this  method  will  not  give  satisfactory  results,  since  it  does 
not  give  effect  to  the  fluctuations  in  inventory  which  must 
inevitably  result  from  the  fluctuations  in  sales.  The  proper 
method  is  to  obtain  the  average  of  the  monthly  inventories. 

Use  of  Turnover  Figures 

Turnover  figures  are  very  useful  in  merchandise  control. 
As  Nystrom,  in  his  "Economics  of  Retailing,"  very  aptly 
says: 

One  of  the  productive  factors  of  a  retail  store  is  the  capital  in- 
vested in  its  stock  of  goods.  When  this  capital  is  borrowed  for  use  in 
the  store,  interest  must  be  paid  for  it,  and  interest  should  be  entered 
as  an  expense  charge  in  any  case  regardless  of  whether  the  manager  of 
the  store  borrows  or  supplies  capital  from  his  own  funds.  Efficiency 
in  its  use  depends  upon  its  activity.  By  activity  is  meant  the  num- 
ber of  times  it  can  be  used  over  and  over  again  in  the  course  of  a 
year.  Each  complete  use  of  the  capital  invested  in  merchandise  is 
known  as  a  "turnover."  If  expenses  and  profits  per  sale  remain 
the  same,  the  greater  the  number  of  turnovers  within  a  year,  the' 
greater  the  net  profit  resulting.  This  fact  has  long  been  recognized. 
There  is  an  old  maxim  that  expresses  the  idea  exactly;  "A  nimble 
sixpence  is  better  than  a  slow  shilling." 


'  McKinsey,  Bookkeeping  and  Accounting,  Vol.  I. 


THE  PURCHASES  BUDGET 


219 


From  the  viewpoint  of  our  present  discussion  we 
are  interested  in  turnover  primarily  as  a  basis  for  determin- 
ing inventory  requirements.  After  the  turnover  of  past 
periods  is  calculated,  it  is  necessary  to  give  it  careful  consid- 
eration before  using  it  as  a  basis  for  merchandise  planning. 
Whether  or  not  the  turnover  of  past  periods  will  be  used  as  a 
basis  for  planning  stock  control  for  the  current  period,  will 
depend  upon  whether  the  average  inventory  of  the  past 
periods  is  deemed  to  be  satisfactory  or  not  for  the  purpose. 

It  may  be  that  the  inventory  during  the  past  periods 
was  too  large  and  the  turnover  too  slow.  Or  it  may  be 
that  the  inventory  was  too  small  for  the  volume  of  sales 
w^hich  w^ere  possible. 

The  merchandise  manager  may  know  that  in  the  case 
of  many  articles  a  much  larger  inventory  was  carried  than 
was  necessary  to  meet  the  volume  of  sales,  and  he  esti- 
mates that  a  smaller  inventory  may  be  carried  during  the 
coming  year  and  the  same  volume  of  sales  be  obtained. 

On  the  other  hand,  he  may  know  of  many  articles  the 
sales  of  which  could  have  been  increased  if  a  larger  variety 
or  assortment  had  been  carried,  or  if  the  goods  desired  by 
the  customer  had  always  been  on  hand  when  called  for. 
He  may  rightly  decide  that  the  turnover  of  past  periods 
must  be  modified  before  it  can  be  used  as  a  basis  in  deter- 
mining the  average  inventory  to  be  maintained  during  the 
current  year. 

The  foregoing  discussion  indicates  two  facts  of  impor- 
tance in  connection  with  inventory  and  turnover.  First,  it 
indicates  that  it  is  unsafe  to  take  average  turnover,  that  is, 
the  average  turnover  of  all  lines  carried,  especially  if  goods 
of  many  different  varieties  are  carried  in  stock.  As  pre- 
viously suggested,  it  is  usually  necessary  to  determine  the 
turnover  of  each  different  class  of  merchandise  carried. 

Secondly,  it  indicates  the  need  for  the  intelligent  consid- 


220 


BUDGETARY  CONTROL 


eration  of  statistics  with  reference  to  past  operations  and 
their  modification  in  the  light  of  past  experience  before  they 
are  used  as  a  basis  of  future  plans. 

Whether  the  turnover  of  the  past  periods  is  deemed 
satisfactory  or  is  modified  as  suggested  above,  a  figure  is 
finally  determined  which  is  used  in  connection  with  the  esti- 
mated sales  of  the  current  period,  to  arrive  at  the  average 
inventory  deemed  necessary  to  meet  these  sales.  The  proc- 
ess involved  is  illustrated  by  the  following  steps : 

1.  Sales  for  the  past  period   $500,000 

2.  Average  inventory  for  the  past  period   $100,000 

3.  Turnover  for  the  past  period   5 

4.  Estimated  sales  for  the  current  period   $600,000 

5.  The  estimated  average  inventory  for  the  current  period  is  $120,000 

It  is,  of  course,  assumed  in  the  foregoing  illustration  and 
discussion  that  the  inventory  and  sales  are  both  stated  at 
the  same  price,  either  both  at  selling  price  or  both  at  cost 
price. 


The  Buying  Budget 

When  the  estimated  inventory  has  been  determined,  it 
is  then  necessary  to  make  a  schedule  of  deliveries  and  pur- 
chases which  will  maintain  this  inventory.  If  the  sales  of 
the  period  fluctuate  to  any  great  extent,  it  will  probably  be 
necessary  to  determine  the  inventory  desired  at  the  begin- 
ning of  each  month-.  Then,  to  determine  the  deliveries  to 
stock  which  must  be  made  during  the  month,  it  will  be 
necessary  to  add  the  estimated  sales  at  cost  for  the  month 
to  the  estimated  inventory  at  the  end  of  the  month,  and 
subtract  the  inventory  at  the  beginning  of  the  month. 

It  can  be  seen  from  the  foregoing  that  the  normal  inven- 
tory, that  is,  the  inventory  which  it  is  estimated  will  have 
to  be  carried  to  meet  the  sales  demands,  may  not  be  an 
average  or  uniform  inventory,  but  may  fluctuate  from 


THE  PURCHASES  BUDGET 


221 


month  to  month  as  the  sales  fluctuate  owing  to  seasonal 
demands,  etc.  It  should  also  be  realized  that  in  many  cases 
it  may  be  desirable  to  make  the  finished  goods  schedule  in 
terms  of  the  number  of  items  required  rather  than  in  terms 
of  value. 

To  illustrate.the  preparation  of  a  schedule  of  deliveries  of 
finished  goods,  it  may  be  assumed  that  the  New  York  De- 
partment Store,  which  makes  a  specialty  of  high-grade 


NEW  YORK  DEPARTMENT 

STORE 

Furniture  Department 

X-Y 

PIANO 

Month 

Stock 
Beginnings 

Sales 

Stock 
End 

Deliveries 
to  Stock 

Memorandum 

Nov. 

16 

Si 

U 

32 

Xmas  season 
begins  Nov.  15 

Dec. 

U 

21 

10 

17 

Xmas  season 
ends  Dec.  18 

Jan. 
Feb. 

10 
15 

17 
32 

15 

s 

22 
25 

Jan.  Bargain 
sales  begin 
Jan.  1920 
Bargain  sale 
ends  Feb.  20 

Figure  i8.    Schedule  of  Deliveries  to  Stock 


pianos  in  its  furniture  department,  desires  to  set  up  a  sched- 
ule of  deliveries  to  stock  of  a  certain  grade  of  piano  during 
the  months  of  November,  December,  January,  and  Feb- 
ruary. Such  a  schedule  may  be  in  the  form  showTi  in 
Figure  1 8. 

A  similar  schedule  of  finished  goods  deliveries  will  need 
to  be  prepared  for  each  item  of  finished  stock.    If  the  sched- 


222 


BUDGETARY  CONTROL 


ule  is  made  in  terms  of  value,  the  only  difference  will  be  the 
method  of  stating  the  quantity  in  each  column. 

Responsibility  for  Preparation  of  Estimate  of  Purchases 

As  to  the  unit  of  the  organization  which  should  be  held 
responsible  for  the  preparation  of  the  estimate  of  pur- 
chases, no  arbitrary  rule  can  be  established.  The  nature, 
size,  and  organization  of  the  business  must  be  considered  in 
each  case.  In  so  far  as  possible  the  purchases  estimate, 
like  all  other  estimates,  should  be  made  by  those  who  are 
responsible  for  its  enforcement. 

In  a  business  with  branches  which  handle  resale  ma- 
terial, the  branch  manager  may  make  the  purchases  which 
his  branch  needs,  under  the  supervision  and  functional  con- 
trol of  the  general  purchasing  agent  of  the  company.  In 
this  case  each  branch  manager  should  be  held  responsible  for 
making  an  estimate  of  the  purchases  of  his  branch.  These 
original  estimates  of  the  branch  managers  will  be  gone  over 
by  the  general  purchasing  agent,  who  will  transmit  them 
with  his  approval  to  the  executive  in  charge  of  the  budgetary 
procedure,  who  in  turn  will  transfer  them  to  the  budget 
committee  for  consideration  and  approval. 

Although  revisions  may  have  to  be  made  in  the  estimates 
submitted  by  the  branch  managers,  it  is  desirable  that  they 
prepare  these  for  two  reasons: 

1.  They  will  take  more  interest  in  their  execution  if  they  are  re- 

sponsible for  their  preparation.  If  they  receive  an  estimate 
prepared  by  someone  else,  they  may  not  feel  the  proper  amount 
of  responsibility  for  any  variations  between  the  actual  and 
the  estimated  figures. 

2.  In  the  making  of  their  estimates  the  branch  managers  must 

study  past  operations  and  plan  future  ones.  This  study 
and  planning  will  be  of  much  value  to  them;  it  will  bring 
to  their  attention  many  things  which  they  would  otherwise 
not  notice. 


THE  PURCHASES  BUDGET 


223 


In  a  department  store  the  head  of  each  department  is 
responsible  for  the  preparation  of  the  estimate  of  purchases 
for  his  department.  In  preparing  this,  he  may  employ  the 
assistance  of  the  various  buyers  in  his  department.  After 
being  prepared,  these  departmental  estimates  will  be  ex- 
amined by  the  merchandise  manager,  who  will  make  such 
revisions  as  he  deems  necessary. 

In  a  business  where  all  purchases  are  made  by  a  central 
purchasing  department  under  the  control  of  a  general  pur- 
chasing agent,  the  estimate  of  purchases  may  be  prepared 
under  his  direction,  but  he  will  usually  obtain  the  assistance 
and  advice  of  subordinates  in  its  preparation,  and  his  esti- 
mate will  be  based  on  the  estimated  requirements  submitted 
by  the  various  departments. 

Whatever  is  the  origin  of  the  original  estimate,  it  will  be 
transferred  to  the  executive  in  charge  of  the  budgetary  pro- 
cedure, and  by  him  submitted  to  the  budget  committee  for 
consideration  and  approval. 

Purchases  Budget  Control 

The  purchases  budget  provides  a  working  program  for 
the  current  period.  But  this  program  is  based  on  estimates 
which,  however  carefully  made,  may  prove  inaccurate  be- 
cause of  market  conditions  that  could  not  be  foreseen  at 
the  time  these  estimates  were  made.  If  the  estimates 
prove  incorrect,  it  is  necessary  to  change  as  soon  as  possible 
the  plans  which  were  based  on  them.  If  it  is  estimated  that 
the  sales  for  the  current  year  will  be  25  per  cent  more  than 
they  were  for  the  past  year,  a  purchases  budget  will  provide 
for  a  corresponding  increase  in  purchases.  But  if  at  the 
end  of  the  first  month  the  sales  have  not  increased  and  mar- 
ket conditions  indicate  that  the  anticipated  increases  will 
not  materialize,  it  would  be  very  unwise  to  continue  to  fol- 
low the  original  purchases  budget.    It  is  necessary,  there- 


'i 


224 


BUDGETARY  CONTROL 


fore,  to  have  certain  records  and  reports  to  make  possible  a 
revision  of  the  purchases  budget  throughout  the  year,  if  the 
results  during  the  year  make  such  a  revision  necessary. 

A  revision  of  purchase  quotas  to  meet  changing  trade 
conditions  is  not  a  simple  task  in  the  case  of  a  department 
store  where  quotas  are  made  out  months  in  advance  on 
thousands  of  different  items.  Perhaps  the  simplest  way  to 
make  changes  on  numerous  quotas  is  to  compute  the  per- 
centage that  the  delivery  quota  for  the  month  is  to  the  esti- 
mated sales  for  the  month.  Thus,  if  the  estimated  sales  are 
43  units  and  the  delivery  quota  is  38  units,  we  may  express 
the  quota  as  88.3,  so  that  if  the  actual  sales  are  51  units  we 
may  permit,  without  being  criticized,  the  delivery  into  stock 
of  88.3  per  cent  of  51  units,  or  45  units.  For  reasons  that 
are  obvious,  this  percentage  method  does  not  give  us  a  quota 
that  will  result  in  the  exact  inventory  at  the  end  of  the 
month  for  which  we  originally  planned.  But  this  use  of  per- 
centages is  decidedly  useful  for  revising  large  numbers  of 
quotas  to  meet  discrepancies  between  estimated  and  actual 
sales. 

There  should  be  prepared  monthly  for  the  use  of  the 
executives  responsible  for  the  purchasing  program  and  for 
the  budget  committee,  a  report  similar  in  form  to  Figure  19. 

Interpretation  of  Illustration 

The  amounts  given  for  each  item  or  line  of  goods  in  the 
first  money  column  will  be  taken  from  the  last  revision  of 
the  sales  program.  In  columns  (4)  and  (5)  a  comparison  is 
given  between  the  delivery  to  stock  quota  on  each  item  and 
the  estimated  sales  at  cost  for  the  item.  It  must  be  remem- 
bered that  estimated  sales  are  taken  at  cost  so  that  there 
may  be  this  comparison  between  sales  at  cost  and  purchase 
quotas  at  cost.  In  column  (6)  a  percentage  of  the  quota  to 
sales  at  cost  is  shown  for  each  item.    The  data  for  column 


THE  PURCHASES  BUDGET 


225 


226 


BUDGETARY  CONTROL 


(6)  is  not  taken  from  the  accounts,  but  is  the  result  of  divid- 
ing estimated  sales  at  cost  into  quotas.  The  actual  sales  for 
the  month  shown  in  column  (7)  will  be  taken  from  the  sales 
as  reported  in  the  sales  accounts  of  the  month.  From  the 
sales,  as  reported  in  the  sales  accounts,  estimated  gross 
profit  is  subtracted.  When  actual  inventory  has  been 
taken  at  the  end  of  the  month,  actual  gross  profits,  as  shown 
by  the  accounts,  should  be  subtracted.  The  revised  quotas 
given  in  column  (8)  may  be  made  by  applying  the  quota 
percentage  given  in  column  (6)  to  actual  sales  at  cost  as 
given  in  column  (7) .  The  amounts  of  deliveries  into  finished 
stock,  as  shown  in  column  (9),  will  be  taken  from  the  pur- 
chase accounts.  The  orders  outstanding  as  shown  in  col- 
umn (11)  will  be  taken  from  an  order  register  if  a  book 
record  of  orders  is  maintained,  or  they  may  be  found  by 
adding  the  unfilled  orders  on  file. 

If  a  monthly  quota  system  is  maintained  on  stock  de- 
liveries, the  unfilled  orders  at  the  end  of  a  month  furnish 
useful  information  to  use  as  a  basis  for  purchase  control. 
It  may  be  that  unfilled  orders  represent  poor  buying,  or  it 
may  be  that  they  represent  a  lack  of  coordination  of  the 
activities  between  the  purchase  and  other  departments  of 
the  business.  In  any  case,  the  reason  for  such  unfilled 
orders  should  be  determined  and  such  executive  action 
taken  as  is  necessary  to  remedy  the  condition. 

Use  of  Control  Reports 

Control  reports  are  a  necessity  to  the  head  buyer  of  a 
store  if  the  activities  of  the  various  assistant  buyers  are  to 
be  coordinated  so  that  they  may  all  work  towards  a  common 
end.  He  makes  use  of  purchase  quotas  and  the  subsequent 
reports  on  these  quotas  for  the  unification  of  the  plans  of 
his  buying  organization.  The  quota  set  up  on  article  S485, 
a  shoe,  is  coordinated  with  the  quotas  set  up  on  article  H563, 


THE  PURCHASES  BUDGET 


227 


a  silk  stocking,  because  both  the  shoe  and  silk  stocking  are  of 
a  certain  color,  shade,  and  quality,  and  are  expected  to 
be  sold  together  in  many  cases.  In  like  manner,  there 
will  be  planning  on  quotas  of  staple  articles  with  reference 
to  certain  proposed  bargain  sales,  and  also  on  quotas  of 
certain  specialties  with  reference  to  their  use  as  liners.  In 
the  same  manner,  quotas  on  various  lines  and  variety  of 
goods  are  considered  in  connection  with  each  other  to  the 
end  that  a  well-coordinated  sales  and  purchase  program  may 
be  formulated.  And  then  reports  are  made  on  these  quotas 
which  serve  as  a  means  of  correcting  errors  of  judgment  on 
the  original  quotas  and  of  detecting  failures  to  execute  prop- 
erly the  program  based  on  these  quotas. 


CHAPTER  XV 


THE  PURCHASES  BUDGET  (Continued) 

Disbursements  for  Purchases 

The  discussion  in  the  preceding  chapter  has  dealt 
primarily  with  the  method  of  securing  a  coordination  be- 
tween purchases  and  sales.  This  is  essential,  but  in  addi- 
tion it  is  necessary  to  provide  for  the  coordination  of 
purchases  with  finances.  To  do  this  it  is  necessary  to 
determine  the  monthly  expenditures  in  payment  of  pur- 
chases. 

The  finished  goods  budget  shows  the  deliveries  to  stock. 
From  the  viewpoint  of  financial  requirements,  it  is  necessary 
to  determine  when  the  goods  delivered  are  to  be  paid  for. 
The  method  of  doing  this  will  depend  on  the  volume  of 
purchases  to  be  made,  and  the  terms  on  which  they  are  to 
be  purchased.  It  may  be  necessary  to  classify  all  purchases 
made  by  credit  terms  so  as  to  obtain  the  data  by  means  of 
which  an  estimate  can  be  made  as  to  the  amount  of  the 
estimated  purchases  which  will  be  made  on  such  terms. 
It  will  then  be  possible  to  estimate  the  disbursements  which 
will  be  made  for  the  purchases  made  on  each  kind  of  terms. 

To  illustrate,  if  it  is  found  that  50  per  cent  of  the  pur- 
chases during  the  past  three  years  have  been  on  terms  2/10, 
n/30,  ancl  that  the  payment  is  always  made  within  the 
discount  period,  it  may  be  estimated  that  50  per  cent  of 
estimated  purchases  for  the  next  period  will  be  paid  within 
ten  days  after  the  receipt  of  the  invoice.  On  this  basis  it 
may  be  estimated  that  two-thirds  of  the  merchandise  pur- 
chased on  these  terms  which  is  to  be  delivered  during  the 
next  month,  will  be  paid  during  that  month,  and  that  in 

228 


THE  PURCHASES  BUDGET 


229 


addition  it  will  be  necessary  to  pay  during  the  month  for 
one-third  of  the  merchandise  purchased  on  these  terms 
during  the  preceding  month. 

In  the  same  manner,  estimates  can  be  made  for  dis- 
bursements to  be  made  in  payment  for  merchandise  pur- 
chased on  each  class  of  terms.  The  errors  which  may  arise 
in  making  such  estimates  are  apparent.  There  are  a  num- 
ber of  factors  which  influence  their  exactness.  It  is  well 
to  remember,  however,  that  cash  receipts  and  disbursements 
can  never  be  estimated  with  absolute  exactness.  The  cash 
balance  is  maintained  to  provide  for  this  inaccuracy  in  the 
same  way  as  the  inventory  of  finished  goods  is  carried  to  ' 
provide  for  the  inaccuracy  of  the  sales  and  purchases  esti- 
mates. Further  discussion  of  the  method  of  estimating 
disbursements  will  be  found  in  Chapter  XIX  in  connection 
with  the  treatment  of  the  financial  budget. 

Report  on  Disbursements  for  Purchases 

As  a  means  of  controlling  the  disbursements  for  pur- 
chases and  of  providing  data  for  the  financial  budget,  it  is 
well  to  have  an  estimate  made  as  shown  in  Figure  20. 

The  form  as  given  is  premised  on  a  budget  period  of 
three  months  in  length.  It  can  of  course  be  adapted  for 
use  for  a  budget  period  of  any  length,  but  the  longer  the 
period,  the  more  inaccurate  the  estimates  for  the  latter 
part  of  the  period  are  apt  to  be.  In  any  case,  it  should  be 
revised  monthly  on  the  basis  of  the  monthly  reports,  show- 
ing actual  sales,  actual  purchases,  and  actual  disbursements. 

Use  of  Estimate  of  Disbursements  for  Purchases 

The  report  shown  in  Figure  20  provides  information 
which  is  of  value  not  only  in  judging  the  advisability  of  the 
contemplated  purchasing  program,  but  also  the  advisability 
of  the  contemplated  sales  and  financial  programs.  The 


BUDGETARY  CONTROL 


most  important  items  of  information  which  it  shows  are 
the  following : 

1.  The  estimated  deliveries  to  stock  during  the  month.    This  can 

be  checked  against  the  same  item  on  the  schedule  of  deliveries 
to  finished  goods  to  determine  the  accuracy  of  the  amount. 

2.  The  estimated  orders  to  be  placed  during  the  month.  This 

provides  a  check  on  the  amount  of  orders  which  are  to  be 
placed  for  future  delivery.  This  enables  the  executives  to 
know  the  plans  of  the  merchandise  or  purchasing  department 
so  that  they  can  curtail  these  plans  if  they  deem  this  necessary. 
It  indicates  to  the  treasurer  the  possible  demand  for  funds  for 
the  payment  of  vendors'  claims. 

3.  It  shows  the  estimated  inventory  at  the  end  of  the  period.  By 

comparing  this  with  the  inventory  at  the  beginning  of  the 
period,  it  can  be  seen  whether  the  purchasing  program  con- 
templates an  increase  in  inventory'.  If  so,  the  reason  for  this 
increase  can  be  ascertained.  It  may  of  course  be  desirable  for 
the  inventory  to  be  increased  for  several  reasons  which  are  no 
doubt  apparentto  the  reader, but  it  iswell  forthe  contemplated 
increase  to  be  called  to  the  attention  of  the  principal  executives 
for  their  approval. 

4.  It  shows  the  disbursements  to  be  made  during  the  month  for 

purchases  made  during  previous  months.  These  are  disburse- 
ments which  presumably  must  be  met,  since  the  contracts  are 
already  made.    This  is  useful  information  for  the  treasurer. 

5.  It  shows  the  estimated  disbursements  for  purchases  made  during 

the  month.  This  amount  is  of  course  subject  to  change  in 
case  the  estimated  purchases  are  changed. 

The  estimate  of  purchase  disbursements  as  a  whole 
provides  information  which  is  useful  in  estimating  the 
financial  requirements  of  the  contemplated  sales  program. 
If  such  requirements  are  too  great,  a  revision  of  the  sales 
program  may  be  necessary. 

Classification  of  Purchase  Data  for  Control  Purposes 

The  discussion  in  the  preceding  chapter  has  pointed  out 
the  necessity  for  records  and  accounts  for  purchases,  and 


232 


BUDGETARY  CONTROL 


the  need  for  records  and  files  for  unfilled  orders  if  informa- 
tion is  to  be  available  for  the  preparation  and  control  of 
the  purchase  program.  But  this  information  must  not 
only  be  available,  it  must  be  available  in  such  form  as  to 
make  this  control  comprehensive  and  not  unduly  burden- 
some. For  that,  it  is  necessary  that  a  proper  classification 
of  purchase  accounts  and  purchase  orders  be  maintained. 
The  classification  which  is  necessary  for  the  preparation  of 
the  monthly  report  shown  in  Figure  19  (page  225)  is  indi- 
cated by  the  report  itself. 

For  the  purpose  of  this  report  the  purchase  accounts 
must  analyze  the  purchases  into  the  same  classes  by  which 
they  are  shown  on  the  purchases  budget,  and  outstanding 
orders  must  be  classified  in  the  same  manner.  For  in- 
stance, if  the  purchases  budget  states  a  separate  quota  for 
twenty  different  types  of  purchases,  there  must  be  twenty 
different  accounts  maintained  with  purchases,  or  some 
supplementary  record  must  be  kept  which  provides  for 
such  a  classification  if  the  monthly  report  shown  in  Figure 
19  is  to  be  used  effectively.  The  outstanding  orders  must 
also  be  subject  to  such  a  classification  if  the  desired  in- 
formation for  column  (10)  is  to  be  obtained.  But  if  this 
report  is  to  be  properly  interpreted  after  it  is  made,  ad- 
ditional information  with  reference  to  purchases  made  and 
orders  issued  is  necessary,  and  to  obtain  this  information 
other  classifications  must  be  maintained. 

Classification  of  Purchase  Invoices 

Purchases,  in  addition  to  being  classified  to  correspond 
to  the  analysis  shown  on  the  purchases  budget,  may  be 
analyzed  as  follows :  /" 

1.  By  departments  or  units  of  responsibility 

2.  By  terms  of  credit 

3.  By  buyers 


THE  PURCHASES  BUDGET 


233 


In  a  business  where  there  is  any  attempt  toward  func- 
tional organization  and  control,  both  sales  and  purchases 
are  usually  classified  according  to  the  units  of  organization 
for  responsibility.  Expenses  are  classified  similarly,  and 
consequently  the  efficiency  of  the  functional  managers  can 
be  judged  in  terms  of  profit  and  loss.  For  instance,  in  a 
department  store  the  departmental  managers  are  held 
responsible  for  the  operations  of  their  departments,  and 
consequently  the  sales  and  purchases  are  analyzed  by  de- 
partments so  that  departmental  profit  and  loss  can  be 
determined.  In  such  a  business  the  sales  estimates  and 
purchasing  estimates  are  usually  made  separately  for  each 
department,  so  that  the  departmental  analyses  serve  a 
double  purpose  in  that  they  serve  not  only  as  a  check  upon 
the  efficiency  of  departmental  heads,  but  also  as  a  basis  for 
the  preparation  and  control  of  the  departmental  estimates. 
In  a  business  with  branches,  the  responsibility  for  the 
management  of  each  branch  is  imposed  on  the  branch 
manager,  and  in  order  to  determine  his  efficiency  an 
analysis  of  purchases,  sales,  and  expenses  by  branches 
is  necessary. 

In  planning  the  financing  of  a  firm's  operations,  it  is  of 
considerable  value  to  the  financial  executive  to  know  the 
terms  on  which  the  estimated  purchases  will  be  made.  It 
has  been  explained  above  that  the  terms  of  purchase  must 
be  taken  into  consideration  in  the  preparation  of  the  esti- 
mate of  purchases.  If  that  is  done,  the  purchase  invoices 
may  be  analyzed  by  terms  of  credit  so  that  statistics  will 
be  available  to  show  the  purchases  made  on  each  kind  of 
terms.  This  analysis  can  then  be  used  in  estimating  the 
proportion  of  the  total  estimated  purchases  which  will  be 
made  on  each  kind  of  terms  during  the  budget  period. 
Often  this  classification  is  not  shown  on  the  ledger  accounts, 
but  only  in  a  supplementary  record.    In  a  large  business 


234 


BUDGETARY  CONTROL 


where  several  analyses  are  to  be  made,  it  will  probably  be 
obtained  by  a  tabulating  equipment. 

Sometimes  it  is  desirable  to  know  the  quantity  of  pur- 
chases made  by  different  buyers,  and  the  purchase  invoices 
are  analyzed  accordingly.  Such  an  analysis  may  be  of 
value  in  assigning  quotas  to  buyers  and  keeping  a  check  on 
the  amount  purchased  by  different  buyers  or  judging  as  to 
the  wisdom  of  continuing  the  services  of  particular  buyers. 

There  may  be  various  other  classifications  of  purchases 
under  different  circumstances,  such  as  commodity  classifi- 
cation, classification  by  vendors,  etc.  The  classification 
shown  on  the  purchase  budget  is  usually  by  commodities 
or  by  groups  of  commodities. 

Classification  of  Unfilled  Orders 

The  unfilled  purchase  orders,  in  addition  to  being  classi- 
fied according  to  the  analysis  shown  on  the  purchases 
budget,  should  be  classified  so  as  to  show  the  following: 

1.  Month  of  delivery 

2.  Contract  orders 

3.  Orders  subject  to  cancellation 

It  should  be  apparent  that  it  is  quite  important  to  know 
the  month  of  delivery  of  the  goods  for  which  orders  are 
outstanding.  Without  this  information,  it  is  impossible 
to  determine  the  proper  delivery  dates  of  goods  still  to  be 
ordered.  If  orders  are  outstanding  for  goods  to  be  delivered 
six  months  hence,  this  can  have  no  effect  on  purchases 
necessary  to  satisfy  the  needs  of  the  current  month.  The 
time  of  delivery  is  also  of  value  to  the  financial  executive  in 
arranging  for  the  payment  of  the  goods  delivered,  and  to 
the  operating  superintendent  in  planning  to  store  and 
handle  them. 

It  is  also  important  in  planning  future  deliveries  to 


THE  PURCHASES  BUDGET 


235 


know  the  amount  of  contract  orders,  the  period  covered 
thereby,  and  the  extent  to  which  deliveries  under  such 
contracts  are  subject  to  shifting.  It  may  be  desirable  to 
speed  up  deliveries  or  to  delay  them,  depending  on  the  ex- 
tent to  which  the  sales  program  may  exceed  or  fail  to  reach 
the  estimated  program. 

The  amount  of  those  orders  that  are  subject  to  cancella- 
tion is  also  quite  important,  especially  if  it  becomes  neces- 
sary to  reduce  the  buying  quota  because  of  a  failure  of  the 
sales  program  to  attain  the  estimated  goal. 

In  order  that  the  amount  of  each  class  of  purchase 
orders  mentioned  may  be  readily  available,  supplementary 
records  may  be  kept  which  classify  the  orders  as  issued  and 
show  them  as  filled  when  goods  are  received.  But  if  these 
records  are  to  be  of  the  greatest  service,  they  must  be 
accurate,  and  to  this  end  periodical  audits  should  be  made 
to  test  their  accuracy.  Oftentimes,  because  these  records 
are  not  a  part  of  the  general  financial  records,  proper  care 
is  not  given  to  their  operation  and  verification. 

Relation  of  Purchasing  Budget  to  Merchandise  Policies 

The  discussion  in  the  preceding  chapter  has  explained 
the  method  of  determining  the  "normal"  inventory  and  the 
formulation  of  a  purchasing  program  based  on  this  inven- 
tory. A  brief  consideration  of  the  method  employed  in 
determining  the  normal  inventory  will  show  that  it  rep- 
resents what  would  be  a  satisfactory  inventory  under  the 
conditions  of  the  preceding  period.  It  should  be  apparent 
to  the  reader  that  it  is  not  always  safe  to  assume  that  these 
same  conditions  will  continue  during  the  current  period. 
Consequently  the  estimated  average  inventory,  as  deter- 
mined by  the  method  shown  in  the  preceding  chapter,  may 
be  modified  by  a  consideration  of  the  anticipated  market 
conditions  of  the  current  period. 


236 


BUDGETARY  CONTROL 


There  are  many  considerations  which  may  make  such 
modifications  desirable.  It  may  be  thought  desirable  to 
purchase  a  large  amount  of  stock  early  in  the  period  because 
of  an  anticipated  increase  in  price,  or  because  it  is  anticipated 
that  there  may  be  congested  traffic  later,  or  because  of  other 
conditions.  On  the  other  hand,  it  may  be  thought  desir- 
able to  let  the  reser\^e  stock  fall  below  normal  because  of 
an  anticipated  fall  in  the  market  price.  The  merits  of  this 
procedure  have  been  considered  in  Chapter  X,  in  discuss- 
ing the  raw  materials  budget. 

In  some  cases,  changes  in  personnel  of  customers  may 
be  expected  to  increase  turnover,  making  a  smaller  inven- 
tory possible.  For  instance,  a  large  inflow  of  war  workers 
during  the  war  period  increased  the  sale  of  certain  grades 
of  goods  in  some  cases,  and  made  a  more  rapid  turnover 
possible.  On  the  other  hand,  an  attempt  to  cater  to  a  more 
fastidious  trade  may  tend  to  necessitate  a  large  inventory 
in  order  to  provide  the  proper  variety. 

The  foregoing  are  but  a  few  of  the  many  changes  in 
market  conditions  which  may  affect  the  purchasing  pro- 
gram. Comparisons  of  statistics  of  past  years  by  lines  of 
goods,  territories,  and  personnel  of  trade  will  help  in  de- 
termining the  modifications  necessary  to  arrive  at  the 
proper  estimated  inventory  for  the  current  period. 

Use  of  Purchases  Budget  to  Control  Conditions  of  Stock 

The  purchases  budget  may  be  used  in  many  ways  td 
assist  in  the  control  of  various  conditions  of  stock.  If  the 
warehousing  facilities  are  limited,  the  purchases  budget,  by 
providing  for  a  more  or  less  uniform  inventory,  and  conse- 
quently uniform  deliveries  into  stock,  will  prevent  the 
arrival  of  stock  to  an  amount  greater  than  can  be  properly 
stored.  It  can  be  seen  readily  that  if  there  is  not  coopera- 
tion between  the  purchasing  department  and  the  operating 


THE  PURCHASES  BUDGET 


237 


or  warehouse  department,  very  undesirable  situations  may 
arise. 

Again,  if  the  purchases  budget  is  properly  made  and  is 
faithfully  followed,  it  will  be  possible  to  have  a  well-formu- 
lated system  of  reserve  and  forward  stocks,  and  there  will 
be  little  danger  of  the  reser\' e  stocks  being  exhausted  when 
it  is  necessary  to  replenish  the  forward  stock.  In  some  lines 
of  business,  such  as  mail-order  houses  and  wholesalers  of 
standard  lines  of  clothing,  this  is  a  matter  of  prime  im- 
portance. 

A  properly  controlled  buying  budget  will  eliminate  the 
necessity  of  making  omissions  or  substitutions  in  filling 
orders.  The  demands  of  the  orders  are  anticipated  in  the 
sales  estimate  and  the  correlated  buying  budget,  and  the 
goods  are  on  hand  when  the  orders  arrive.  Such  a  budget 
will  also  eliminate  the  need  for  holding  unfilled  sales  orders 
until  goods  are  purchased  with  which  to  fill  them. 

In  short,  the  purchases  budget,  like  the  sales  budget,  is 
one  of  the  connecting  links  between  the  various  departments 
and  serves  as  a  basis  for  coordination  of  all  the  activities  of 
the  business. 

Relation  of  Purchasing  Program  to  Merchandise  Policies 

The  purchasing  program  is  but  one  part  of  the  merchan- 
dise program  and  in  the  formulation  of  the  latter  a  number 
of  factors  must  be  considered.  Some  of  these  factors  are 
external  to  the  business  organization,  while  others  are  mat- 
ters of  internal  policy.  Illustrations  of  the  former  were 
given  in  the  discussion  of  the  relation  of  market  conditions 
to  the  purchases  budget.  Some  of  the  most  important 
internal  factors  which  must  be  given  consideration  in 
merchandise  planning  are : 

1.  Sales  3.  Turnover  5.  Mark-downs 

2.  Inventory  4.  Purchases  6.  Expense 


238 


BUDGETARY  CONTROL 


Each  of  these  factors  must  be  given  careful  consideration  in 
making  the  merchandise  plans  of  each  department,  and 
the  policy  of  the  firm  with  reference  to  each  given  proper 
emphasis. 

It  may  be  said,  by  way  of  caution,  that  "external"  and 
"internal"  factors  which  affect  the  merchandise  plans  are 
closely  related.  Each  may  have  an  effect  on  the  other. 
For  instance,  the  market  conditions  may  be  such  that  the 
company  may  find  it  necessary  to  alter  its  usual  policy  with 
reference  to  inventory,  purchases,  or  expense. 

Importance  of  a  Consideration  of  Expense 

In  the  preceding  discussion  it  has  been  assumed  that  all 
the  plans  of  the  business  are  based  on  the  sales  program. 
It  has  been  explained,  however,  that  the  sales  program  is 
based  not  alone  upon  sales  possibilities,  but  also  upon 
production  or  purchasing  capacity,  expense  requirements, 
and  profit  potentialities.  As  the  expense  factor  is  an  im- 
portant one  in  a  mercantile  business,  it  seems  worth  while 
to  emphasize  again  the  importance  of  giving  it  very  gareful 
consideration  in  forming  the  sales  program  and  the  relative 
purchasing  program. 

It  is  important  to  see  the  anticipated  expenses  of  each 
department  and  to  determine  if  the  sales  program  is  suffi- 
cient to  warrant  the  expenses  planned.  If  that  program  is 
not  sufficient,  it  is  necessary  to  plan  either  for  an  increase 
in  sales  or  for  a  decrease  in  expense.  It  is  beneficial  to  the 
department  head  to  have  the  relationship  between  his  sales 
and  expenses  brought  forcibly  to  his  attention.  After  the 
estimated  expenses  of  the  department  are  determined,  it  is 
well  to  show  the  amount  of  sales  which  are  necessary  to 
make  possible  the  incurrence  of  these  expenses  with  a 
satisfactory  margin  of  profit. 

To  make  this  calculation  it  is  necessary  to  consider  (i) 


THE  PURCHASES  BUDGET 


239 


PRELIMINARY  SIX  MONTHS'  PLANS 

Period  from  ^.M^JL^  to  J^lzl^  

Retail  Stock 
On  Hand  at 

Beoinnino  of  Period — ^  

Desired  at 

End  of  Period—  


DEPT.. 


Retail 


Maximum  Stock. 
Minimum  Stock. 


Mark-Downs  Allowed. 


Initial  Mark-Up  Required 


MONTH 

Jan, 

Feb. 

Mar 

April 

May 

June 

TOTAL 

July 

SALES: 

Last  Year 
Estimated 
Result 

Inventory 
Last  Year 
Estimated 
Result 

TURNOVER: 

Last  Year 
Estimated 
Result 

Purchases: 
Last  Year 
Estimated 
Result 

Mark-Oowns: 
Last  Year 
Estimated 
Result 

Expense: 
Last  Year 

Estimated 
% 

Result 

% 

REMARKS 


Figure  21.    Showing  Merchandise  Plan  of  Each  Department  of  a 
Department  Store 


I 


240 


BUDGETARY  CONTROL 


the  estimated  sales,  (2)  the  average  mark-up,  (3)  the  aver- 
age mark-down,  and  (4)  the  expected  profit.  If  we  assume 
that  the  estimated  expenses  of  Department  A  are  $7,000, 
the  average  mark-up  40  per  cent,  the  average  mark-do\vn 
2  per  cent,  and  the  expected  profit  3  per  cent,  then  the 
necessary  sales  will  be  obtained  by  the  following  calculation : 

$7,000  H-  [40%  -  {2%+ 3%)]  =  $20,000 

If  the  sales  program  of  Department  A  calls  for  sales  of 
less  than  $20,000,  it  must  be  revised  or  else  the  expense  or 
profit  estimate  must  be  revised. 

If  a  merchandise  plan  is  made  based  on  a  close  correla- 
tion between  the  sales,  purchasing,  and  expense  program, 
there  will  be  less  likelihood  of  disappointments  at  the  end 
of  the  period. 

Report  on  Merchandise  Plan 

The  merchandise  plan  of  each  department  of  a  depart- 
ment store  or  wholesale  house  can  be  very  effectively  pre- 
sented for  executive  consideration  by  the  use  of  a  report 
made  in  the  form  shown  in  Figure  21. 

The  information  shown  on  this  report  is  self-explanatory. 
It  serves  not  only  as  a  basis  for  formulating  plans,  but  can 
also  be  used  as  a  means  of  checking  their  performance  since 
it  provides  for  a  comparison  of  the  estimated  and  the 
actual.  If  desired,  sufficient  space  may  be  left  in  con- 
nection with  each  section  so  that  at  the  end  of  each 
month  revisions  may  be  shown  for  each  of  the  following 
months. 

It  will  of  course  be  understood  that  this  general  report 
will  be  supplemented  by  a  number  of  detailed  reports 
which  will  serve  to  explain  the  summary  figures  shown  on 
it.  If  desired,  this  report  may  be  so  designed  as  to  show 
comparisons  by  percentages. 


THE  PURCHASES  BUDGET 


241 


Review  and  Summary 

In  Chapters  V  and  VI  the  formation  and  execution  of 
the  sales  budget  has  been  discussed.  In  Chapters  XIV  and 
XV  an  attempt  has  been  made  to  outHne  the  procedure 
involved  in  the  correlation  of  purchases  with  sales,  and  in 
the  preparation  and  execution  of  the  purchases  budget. 

In  summary  form  this  procedure  may  be  stated  as 
follows : 

I.  Preparation  of  Purchases  Budget 

First.  An  estimate  of  sales  is  made  for  the  period.  To  recapitulate 
wfiat  has  been  said  in  a  preceding  chapter,  this  requires: 

1.  An  analysis  of  the  sales  of  preceding  periods.    The  sales  accounts 

should  furnish  this  analysis.  But  several  analyses  may  be  of 
value  in  arri\  ing  at  the  final  sales  program,  and  it  may  be 
necessary  to  refer  back  to  sales  tickets  or  other  vouchers  for 
data  in  making  this  analysis.  Thus  if  the  sales  accounts  lead 
to  a  report  of  sales  by  lines  of  goods,  it  may  be  of  value  to  refer 
to  analyses  of  sales  by  terms,  by  territories,  etc. 

2.  Use  of  sales  analysis  comparisons  in  estimating  sales  under  existing 

or  future  trade  conditions. 

3.  Revision  of  original  sales  estimates  in  the  light  of  purchasing 

possibilities,  expense  requirements,  and  profit  potentialities. 

4.  Comparison  of  estimates  of  sales  with  actual  sales  accounts  dur- 

ing the  period,  and  correction  of  first  estimate  as  actual  sales 
accounts  show  errors  of  judgment  in  setting  up  the  sales  pro- 
gram. 

Second.  An  estimate  of  turnover  for  the  period  is  made.  To  do  this 
requires : 

1.  Use  of  inventory  accounts  and  sales  accounts  of  past  periods  in 

arriving  at  average  turnover  for  each  line  of  goods  in  com- 
parable past  periods. 

2.  Use  of  past  average  turnover  in  estimating  probable  turnover 

under  the  existing  or  future  trade  conditions. 

Third.  Estimated  average  inventory  for  the  coming  period  is  computed 
for  each  item  or  line  of  finished  stock  to  be  sold  in  the  period.  For  control 
purposes,  these  estimates  are  set  up  in  schedules  of  finished  stock  inventory 

16 


242 


BUDGETARY  CONTROL 


requirements.  As  the  period  advances,  comparisons  are  made  between 
schedules  and  the  amounts  shown  by  the  inventory  accounts,  and  the 
schedules  are  corrected  where  errors  of  judgment  are  apparent  through 
such  comparisons. 

Fourth.  A  schedule  of  deliveries  of  finished  stock  is  made.  To  be 
effective  as  a  basis  for  management  control,  this  schedule  or  estimate  of 
deliveries  should  specify  the  amount  of  each  line  of  goods  that  is  to  be 
placed  in  stock  each  week  or  each  month  of  the  period.  If  the  period 
covers  six  months  commencing  on  January  i,  the  delivery  quotas  may  be 
computed  as  follows: 

Estimated  sales  for  the  month  of  January  at  cost. 

Plus  inventory  expected  on  January  31. 

Less  actual  inventory  on  December  31. 

Equals  delivery  into  stock  quota  for  the  month  of  January. 

Then  for  the  month  of  February. 

Estimated  cost  of  sales  for  February. 

Plus  inventory  expected  on  February  28. 

Less  estimated  inventory  on  January  31. 

Equals  delivery  into  stock  quota  for  month  of  February. 

And  so  on  for  each  of  the  six  months.  If  the  volume  of  sales  is  large  and 
fairly  constant,  as  in  a  mail-order  furniture  line,  such  a  monthly  quota  will 
furnish  reasonably  close  limits  on  purchases.  But  if  the  volume  of  the 
sales  in  the  line  is  subject  to  great  seasonal  variations,  as  in  a  department 
store  wall-paper  line,  a  weekly  quota  should  be  set  up  for  deliveries  into 
stock  during  rush  seasons. 

Fifth.  An  estimate  of  purchases  which  will  satisfy  the  schedule  of 
finished  goods  deliveries  is  set  up.  This  will  show  estimated  orders  to  be 
placed  each  month,  estimated  deliveries  to  be  made,  and  estimated  dis- 
bursements to  be  made  in  settlement  of  vendors'  claims. 

Sixth.  The  schedule  of  finished  goods  deliveries  and  the  estimate  of 
purchases  is  approved  by  the  controlling  executive  authority  with  whom 
final  approval  rests. 

II.  Reports  Used  in  Preparation  and  Execution  of  Purchases 
Budget 

If  it  is  assumed  that  the  buying  budget  for  1922  is  under  consideration, 
the  name  of  each  report  with  the  money  column  headings  of  each  which 
would  be  used  in  its  preparation  and  execution  may  be  as  follows: 


1 


THE  PURCHASES  BUDGET 


243 


First.  Weighted  Average  of  Sales  for  three  years  for  each  class  of 
goods: 

1.  Sales  for  the  year  1919. 

2.  Sales  for  the  year  1 920. 

3.  Sales  for  the  year  1921. 

4.  Arithmetical  average. 

5.  Weighted  average — to  be  used  as  a  basis  for  the  sales  estimate. 

Second.    Sales  program  for  the  year  1922  for  each  item  sold: 

1 .  Weighted  average  for  the  three  years  preceding. 

2.  Per  cent  of  1922  estimated  increases  and  decreases. 

3.  Sales  estimate  for  1922  on  each  item. 

Third.    Monthly  Report  of  Actual  Sales  under  sales  program: 

1.  Sales  estimated  for  period  to  date. 

2.  Actual  sales  for  period  to  date. 

3.  Per  cent  of  increase  or  decrease  of  actual  over  estimated. 

4.  Add  or  deduct  from  sales  program  for  the  rest  of  the  period. 

Fourth.    Estimated  Average  Inventory  by  Classes  or  Goods  and  Items: 

1.  Actual  sales  for  1919,  1920,  1921. 

2.  Less  actual  gross  profit  for  1919,  1920,  192 1. 

3.  1919-1920-1921  sales  at  cost. 

4.  Rate  of  turnover  on  each  item  for  1919,  1920,  192 1. 

5.  Estimated  sales  for  1922. 

6.  Estimated  gross  profit  for  1922. 

7.  Estimated  sales  at  cost  for  1922. 

8.  Estimated  turnover  rate  for  1922. 

9.  Estimated  average  inventory  for  1922. 

Fifth.    Estimate  of  Finished  Goods: 

1.  Month. 

2.  Estimated  inventory  at  beginning  of  the  month. 

3.  Estimated  sales  at  cost. 

4.  Estimated  inventory  at  the  end  of  the  month. 

5.  Estimated  deliveries  to  stock  during  the  month. 

6.  Comments. 

Sixth.    Estimate  of  Purchases: 

1.  Item. 

2.  First  month: 

(a)  Estimated  inventory  at  beginning  of  month. 

(b)  Estimated  deliveries  to  stock  during  the  month. 


244 


BUDGETARY  CONTROL 


(c)  Estimated  orders  to  be  placed  during  the  month. 

(d)  Estimated  inventory  at  the  end  of  the  month. 

(e)  Estimated  cash  disbursements  for  purchases  made  during 

previous  months. 

(f)  Estimated  cash  disbursements  for  purchases  made  during 

the  current  month. 
3.  Second  month: 

The  same  as  for  first  month,  and  so  continued  for  each  month. 

Seventh.    Monthly  Inventory  Comparison  Report: 

1.  Estimated  sales. 

2.  Actual  sales. 

3.  Per  cent  of  increase  or  decrease. 

4.  Estimated  average  inventory. 

5.  Actual  inventory. 

6.  Per  cent  of  increase  or  decrease. 

Eighth.    Monthly  Report  on  Quotas : 

1 .  Estimated  sales  for  month. 

2.  Estimated  gross  profit. 

3.  Estimated  sales  at  cost. 

4.  Purchase  quota. 

5.  Ratio  of  (4)  to  (3). 

6.  Actual  sales  for  month. 

7.  Revised  quota,  per  cent  shown  in  (5)  taken  of  actual  sales  shown 

in  (6). 

8.  Delivered  into  stock  during  the  month — taken  from  the  purchase 

accounts. 

9.  Balance  of  quota  not  delivered  or  excess  of  quota  d<livered. 

10.  Purchase  orders  outstanding  under  quota,  not  delivered. 

11.  Balance  in  quota  not  ordered  or  excess  ordered  over  quota. 

Ninth.    Report  on  Merchandise  Plans  of  Each  Department: 
This  report  may  be  made  in  the  form  in  Figure  21. 


CHAPTER  XVI 


THE  PLANT  AND  EQUIPMENT  BUDGET 

Need  for  Consideration 

In  every  business  there  is  need  for  certain  equipment  to 
be  used  in  carrying  on  its  operations.  The  amount  and 
nature  of  this  equipment  depends  on  the  size  and  the  nature 
of  those  operations.  The  professional  firm  needs  little 
equipment  and  very  rarely  owns  the  building  in  which  it  is 
housed.  The  mercantile  firm  uses  a  limited  amount  of 
equipment,  depending  on  its  size,  and  in  many  cases  does 
not  own  the  building  in  which  it  operates.  The  manufac- 
turing firm  usually  employs  a  large  amount  of  equipment, 
and  in  most  cases  owns  the  plant  in  which  it  carries  on  its 
manufacturing  operations.  Consequently  a  large  part  of 
the  capital  of  most  manufacturing  firms  is  invested  in  their 
plant  and  equipment. 

It  can  be  seen,  therefore,  that  expenditures  for  plant 
and  equipment  are  most  important  in  connection  with  an 
industrial  concern,  but  that  they  are  of  some  significance  in 
the  case  of  all  businesses.  The  following  discussion  will  be 
devoted  primarily  to  a  consideration  of  the  control  of  expend- 
itures for  the  plant  and  equipment  of  a  manufacturing 
business,  but  the  same  principles  will  apply  to  the  control  of 
expenditures  for  plant  and  equipment  of  any  other  type  of 
business. 

Classification  of  Plant  and  Equipment  Expenditures 

The  expenditures  made  in  connection  with  the  plant  and 
equipment  of  a  business  may  be  classified  into  the  following 
general  groups: 

245 


246 


BUDGETARY  CONTROL 


1.  Expenditures  which  are  necessary  to  maintain  the  present  plant 

and  equipment  at  its  normal  efficiency.  No  matter  how  care- 
fully equipment  is  selected  or  how  carefully  it  is  used,  certain 
expenditures  must  be  made  from  time  to  time  to  keep  it  in  such 
condition  that  it  can  be  operated  efficiently.  Such  expendi- 
tures are  called  "repairs." 

2.  Expenditures  which  are  made  to  replace  with  new  equipment, 

old  equipment  that  is  worn  out  and  discarded.  Regardless 
of  the  amount  spent  in  the  way  of  repairs,  equipment  will 
in  time  be  in  such  a  condition  that  it  can  no  longer  be 
operated  profitably.  It  is  necessary  to  purchase  new  equip- 
ment to  take  its  place.  Such  expenditures  are  termed 
replacemejits. 

3.  Expenditures  in  connection  with  present  equipment  which  add 

to  its  life  or  efficiency.  For  instance,  a  machine  may  be  entire- 
ly overhauled;  old  and  worn  parts  are  replaced  by  new  ones, 
■  with  the  result  that  it  will  continue  in  use  longer  than  was 
originally  estimated.  Or  a  new  patent  may  be  added  to  the 
machine  which  will  not  prolong  its  life  but  will  increase  its 
efficiency  during  its  life.  Such  expenditures  are  termed 
"betterments." 

4.  Expenditures  which  are  made  to  obtain  new  equipment  which 

does  not  replace  other  equipment  but  which  represents  an  addi- 
tion to  the  sum  total  of  the  equipment  employed  by  the  busi- 
ness. As  a  business  expands,  it  is  necessary  to  secure  addition- 
al equipment  to  carry  on  the  increased  volume  of  business. 
Expenditures  for  this  purpose  are  termed  "additions." 

Treatment  of  Different  Classes  of  Expenditures 

From  the  viewpoint  of  both  accounting  and  financial 
management,  the  classes  of  expenditures  explained  in  the 
foregoing  discussion  are  distinctly  different  and  must  be 
recorded  carefully  to  show  properly  their  effect  on  the  finan- 
cial condition  and  operating  efficiency  of  the  business.  A 
proper  record  is  necessary  also  for  use  as  a  basis  in  planning 
and  executing  an  effective  control  of  these  expenditures. 
It  will  be  necessary  to  discuss  separately  the  method  of 
recording  and  reporting  each  class. 


THE  PLANT  AND  EQUIPMENT  BUDGET  247 

Repairs 

Repairs  are  usually  considered  as  a  current  expense 
of  the  business,  which  must  be  provided  for  out  of  the 
income  of  the  fiscal  period  in  which  they  occur.  This 
is  on  the  theory  that  repairs  are  necessitated  because 
of  the  operations  of  the  period  when  they  occur  and 
that  consequently  their  cost  should  be  borne  by  that 
period. 

In  opposition  to  this  theory  it  is  sometimes  urged  that 
repairs  are  not  the  result  necessarily  of  the  operations  of  the 
period  when  they  occur,  but  may  be  necessitated  because, 
in  part  at  least,  of  the  operations  of  previous  periods.  In 
other  words,  the  operations  of  one  period  may  cause  a  ma- 
chine to  be  so  worn  that  it  is  almost  ready  to  break  down 
at  the  end  of  the  period,  but  the  break  with  the  consequent 
repair  may  not  actually  occur  until  the  beginning  of  the 
next  period.  The  customary  practice  assumes,  however, 
that  repairs  "even  up"  from  period  to  period,  since  each 
period  suffers  repairs  caused  in  part  by  the  operations  of 
previous  periods,  and  in  turn  transfers  "potential  repairs" 
to  the  next  period.  Consequently,  it  is  argued  that  the 
cost  of  repairs  tends  to  be  approximately  uniform  from 
period  to  period. 

If,  for  any  reason,  the  cost  of  repairs  fluctuates  to  any 
extent  from  period  to  period,  and  it  is  desired  to  distribute 
their  cost  evenly,  this  may  be  accomplished  by  estimating 
the  average  cost  of  repairs  on  the  basis  of  past  experience 
and  future  plans,  and  setting  up  a  reserve  for  repairs. 
Under  this  method  there  will  be  charged  to  expense  and 
credited  to  a  reserve  for  repairs  an  amount  equal  to  the 
estimated  cost  of  repairs.  As  the  repairs  take  place  they 
are  charged  to  the  reserve  for  repairs. 

If  standard  rates  for  repairs  are  established,  the  prepa- 
ration of  the  manufacturing  expense  budget  is  facilitated. 


248 


BUDGETARY  CONTROL 


This  procedure  also  assists  in  the  estabhshment  of  standard 
expense  rates  such  as  were  discussed  in  Chapter  XIII. 

Replacements 

The  cost  of  replacements  is  not  an  expense  of  the  period 
when  the  replacement  takes  place,  but  is  an  expense  of  all 
the  periods  during  which  the  equipment  which  is  replaced 
has  been  used.  If  a  machine  costing  $  i  ,000  is  purchased  in 
1 92 1,  the  year  1 921  should  not  bear  the  entire  cost  of  the 
new  machine,  neither  should  it  bear  the  difference  between 
the  cost  and  the  scrap  value  of  the  old  machine.  Each  of 
the  six  years  during  which  the  machine  has  been  used  has 
received  a  benefit  from  its  use,  and  consequently,  each  of 
the  six  years  should  be  charged  with  a  part  of  its  cost.  If 
the  scrap  value  of  the  machine  is  $100,  the  six  years  during 
which  the  machine  has  been  used  must  be  charged  with 
$900  for  its  use. 

As  to  whether  each  year  should  be  charged  an  equal 
amount,  there  is  no  unanimity  of  opinion.  It  depends 
upon  the  method  of  "depreciation"  that  is  adopted.  It  is 
not  deemed  desirable  at  this  time  to  enter  into  a  discussion 
of  the  different  methods  which  may  be  employed.  It  is 
important  to  see,  however,  that  the  estimated  decrease  in 
value  of  the  asset  due  to  the  operations  of  the  business  each 
year  must  be  charged  against  the  income  derived  from  these 
operations. 

Since  the  actual  expenditures  for  any  particular  equip- 
ment take  place  at  one  time,  and  not  during  each  year  of  its 
use,  it  is  customary  to  credit  the  estimated  depreciation  of 
each  period  to  a  reserve  for  depreciation  account  and  to 
debit  an  expense  account  for  the  same  amount.  When  the 
asset  is  sold  or  discarded,  it  is  charged  against  the  reserve 
account.  By  this  means  the  cost  of  equipment  is  charged 
against  the  income  of  the  periods  which  benefit  from  its  use. 


I 


THE  PLANT  AND  EQUIPMENT  BUDGET  249 


The  new  equipment  which  is  purchased  to  take  the  place  of 
the  old  is  charged  to  the  asset  account. 

Betterments 

When  betterments  are  made,  future  periods  will  be 
benefited  either  through  the  increased  efficiency  of  the 
equipment  concerned,  or  through  its  longer  life,  and  hence 
replacement  costs  are  postponed.  In  either  case,  since 
future  periods  are  to  receive  the  benefit  of  such  better- 
ments, they  should  bear  the  cost  of  the  betterments. 
Hence  betterments  are  charged  to  asset  accounts  and  are 
not  reflected  in  the  expense  accounts  of  the  period  in  which 
they  are  incurred. 

It  is  often  difficult  to  distinguish  between  a  betterment 
and  a  repair.  In  many  cases  an  expenditure  is  partly  one 
and  partly  the  other.  To  take  a  classic  illustration,  if  a 
wooden  roof  is  replaced  by  a  slate  roof,  so  much  of  its  cost 
as  would  have  been  incurred  if  a  wooden  roof  had  been  used 
will  be  treated  as  a  repair,  while  the  excess  of  the  cost  of  the 
slate  over  a  wooden  roof  will  be  treated  as  a  betterment. 
In  case  of  doubt,  it  is  the  practice  of  accountants  to  be  con- 
servative and  treat  the  expenditure  as  a  repair. 

Additions 

Additions  to  plant  and  equipment  are  made  for  the  bene- 
fit of  future  periods.  Hence  their  cost  is  not  charged  to  the 
period  in  which  they  are  obtained  but  is  distributed,  by 
means  of  the  periodical  depreciation  charge,  over  the  pe- 
riods during  which  they  are  used.  Consequently,  additions 
are  a  capital  and  not  a  revenue  charge. 

It  must  be  realized,  however,  that  as  soon  as  additions 
are  secured  they  give  rise  to  revenue  charges,  since  a  charge 
for  depreciation  must  be  made  at  the  end  of  each  fiscal 
period  to  provide  for  their  replacement. 


250 


BUDGETARY  CONTROL 


Capital  vs.  Revenue  Charges 

From  the  foregoing  discussion  it  can  be  seen  that  from 
the  view'point  of  accounting,  plant  and  equipment  gives  rise 
to  two  kinds  of  charges: 

1.  Those  which  are  made  to  wawtom  the  present  equipment.  Re- 

pairs and  replacements  are  included  in  this  group.  These 
may  be  termed  "  maintenance  "  costs.  They  must  be  included 
in  the  periodical  expense  accounts;  or  to  use  technical  termi- 
nology, they  are  "charged  against  revenue."  Many  authori- 
ties do  not  include  provision  for  replacements  (that  is,  the 
periodical  depreciation  allowance)  as  an  item  of  maintenance 
cost.  From  the  viewpoint  of  a  maintenance  budget,  this  in- 
clusion is  desirable  and  no  difficulty  arises  if  the  definition 
of  maintenance  precedes  its  use. 

2.  Those  charges  which  represent  an  addition  to  the  assets  of  the 

business.  Betterments  and  addition^  are  included  in  this 
group.  These  axe  termed  "plant  and  equipment  costs." 
They  are  charged  to  the  asset,  or  to  use  technical  terminology, 
they  are  "charged  to  capital." 

Method  of  Handling  Maintenance  Charges 

The  preceding  discussion  has  dealt  with  the  method  of 
recording  these  two  classes  of  charges.  The  following  dis- 
cussion will  deal  primarily  with  the  method  of  exercising 
control  over  their  amount. 

Maintenance  charges  on  plant  and  equipment  used  in 
production  are  a  part  of  manufacturing  expenses  and  should 
be  included  in  the  manufacturing  expense  budget.  This  is 
necessary  in  order  to  judge  the  effect  of  the  contemplated 
production  program  on  the  amount  of  the  manufacturing 
expense.  It  is  also  necessary  in  determining  costs  of  manu- 
facturing product  and  in  the  establishment  of  standard 
rates. 

It  is  desirable  that  the  maintenance  costs  also  be  shown 
on  the  plant  and  equipment  budget,  since  this  makes  it 
possible  to  obtain  a  comprehensive  picture  of  the  plant  and 


THE  PLANT  AND  EQUIPMENT  BUDGET  251 


equipment  program  as  a  whole.  Their  appearance  on  the 
plant  and  equipment  budget  also  facilitates  the  establish- 
ment of  appropriations  for  them.  If  the  manufacturing 
expense  budget  and  the  plant  and  equipment  budget  are 
prepared  by  different  units  of  the  organization,  which  is 
usually  the  case,  the  maintenance  charges  appearing  on  the 
two  budgets  can  be  checked  against  each  other,  which  will 
tend  to  correct  errors  made  by  either  party  in  making  the 
estimate.  If  there  is  a  disagreement  between  the  estimates 
shown  on  the  two  budgets,  this  should  be  reconciled,  if  pos- 
sible, by  the  parties  responsible  for  it.  If  this  cannot  be 
done,  it  will  be  necessary  to  submit  the  disagreement  to  the 
budget  committee  for  settlement. 

It  must  of  course  be  remembered  that  in  preparing  the 
financial  budget  and  also  the  estimated  statement  of  profit 
and  loss,  the  cost  of  maintenance  must  be  taken  from  only 
one  budget. 

Requirements  for  Plant  and  Equipment  Control 

To  exercise  effective  control  over  disbursements  for 
plant  and  equipment,  three  things  are  necessary : 

1.  There  must  be  available  data  which  will  show  results  of  past 

operations  and  serve  as  the  basis  of  future  plans. 

2.  After  all  the  available  data  have  been  considered,  the  plans  which 

have  been  formulated  must  be  expressed  in  workable  form  by 
means  of  a  budget  on  plant  and  equipment.  Sometimes  two 
budgets  are  made,  one  on  maintenance  costs  and  one  on  the 
cost  of  betterments  and  additions.  The  requirements  for  each 
are  sufficiently  similar  to  make  their  joint  discussion  possible. 

3.  After  the  budget  is  made,  it  is  necessary  to  have  records  and  re- 

ports prepared  which  will  make  possible  the  control  of  such 
expenditures  and  the  enforcement  of  the  budget  plans. 

Data  Required  as  Basis  of  Control 

The  data  required  to  serve  as  a  basis  for  control  of  plant 
and  equipment  expenditures  may  be  classified  as  follows: 


252 


BUDGETARY  CONTROL 


1.  That  which  is  obtained  from  the  accounting  and  statistical  rec- 

ords with  reference  to  past  experience. 

2.  That  which  is  obtained  by  a  mathematical  calculation  based  on 

predetermined  factors. 

3.  That  which  is  determined  by  a  consideration  of  future  plans. 

4.  That  which  is  obtained  as  a  result  of  the  investigation  and  study 

of  experts. 

Accounting  and  Statistical  Data 

To  make  plans  which  will  serve  to  control  expenditures 
for  plant  and  equipment,  it  is  necessary  that  a  proper  classi- 
fication of  the  plant  and  equipment  be  made  and  that 
proper  records  be  maintained  which  reflect  this  classifica- 
tion. This  classification  is  necessary  to  make  an  accurate 
estimate  of  plant  and  equipment  expenditures. 

To  illustrate,  in  a  manufacturing  business  the  plant  and 
equipment  expenditures  will  vary  with  the  production  pro- 
gram. If  production  is  to  be  increased  it  will  be  necessary 
to  do  one  or  both  of  two  things :  ( i )  secure  additional  equip- 
ment; (2)  use  present  equipment  more  intensively.  In 
either  case,  additional  expenditures  will  be  incurred,  and  to 
estimate  accurately  the  amount  of  these  expenditures  it  is 
necessary  to  consider  carefully  the  various  kinds  of  equip- 
ment used  in  production. 

If  additional  equipment  is  to  be  secured  it  will  be  neces- 
sary to  determine  the  units  of  equipment  used  in  the  past 
and  the  amount  of  production  which  has  been  accomplished 
with  this  equipment.  On  this  basis,  the  additional  equip- 
ment required  to  secure  the  increased  production  capacity 
can  be  estimated.  That  the  past  production  capacity  may 
be  obtained  accurately,  a  record  of  each  unit  of  equipment 
is  necessary. 

If  the  present  equipment  is  to  be  used  more  intensively, 
this  will  increase  the  maintenance  cost,  and  an  estimate  of 
this  increase  must  be  made.    It  should  be  obvious  that  a 


THE  PLANT  AND  EQUIPMENT  BUDGET 


253 


change  in  the  production  program  will  not  affect  all  the 
equipment  of  the  business  to  the  same  extent.  For  instance, 
it  may  be  planned  to  increase  the  output  of  one  department, 
while  the  output  of  all  the  remaining  departments  is  to  re- 
main the  same.  This  increase  in  the  output  of  one  depart- 
ment is  very  apt  to  increase  the  maintenance  expense  of 
this  department,  and  if  the  previous  expense  is  shown  sepa- 
rately from  that  of  all  the  other  departments,  a  more  accu- 
rate estimate  of  the  increase  can  be  made.  It  will  be 
necessary,  however,  to  know  more  than  the  total  cost  of  the 
maintenance  of  the  department.  The  new  program  will 
probably  affect  some  units  of  equipment  in  the  department 
more  than  it  will  others.  It  is  desirable,  therefore,  to  have 
records  which  will  show  each  unit  of  equipment  in  the  de- 
partment, and  the  maintenance  expense  incurred  on  it. 
This  is  accomplished  by  keeping  a  plant  ledger. 

Plant  Ledger 

A  plant  ledger  is  a  record  which  contains  an  account  with 
each  unit  of  plant  and  equipment.  It  serves  as  a  subsidiary 
record  to  the  controlling  account  or  accounts  with  plant  and 
equipment  which  are  kept  on  the  main  ledger.  The  plant 
ledger  is  usually  kept  on  cards  or  loose-leaf  sheets,  each  card 
or  sheet  providing  a  record  of  one  unit  of  equipment.  The 
size  of  this  unit  will  var>',  depending  on  conditions.  There 
may  be  a  separate  account  for  each  machine,  or  if  several 
machines  of  the  same  pattern  and  size  are  purchased  at  the 
same  time,  they  may  all  be  recorded  in  one  account. 

Each  account  in  the  plant  ledger  should  show  at  least 
three  things: 

1 .  The  original  cost  of  equipment  and  the  date  of  purchase. 

2.  The  amount  of  depreciation  which  has  accrued  on  the  equipment 

to  date. 

3.  Its  present  book  value. 


254 


BUDGETARY  CONTROL 


In  addition  the  account  may  show  the  amount  of  the  repairs 
which  have  been  made  on  the  equipment  to  date. 

It  will  be  understood  that  the  repairs  entered  on  the 
plant  ledger  account  will  not  affect  the  value  of  the  equip- 
ment, since  they  are  treated  as  an  expense  and  are  never 


PLANT  LEDGER 


Made                      Maker's  Acct. 
Name  of  Item  By  No.  No_ 

 BIdg.  ^Dept. 


Indicate  below  whether  machine 
proper,  accessories,  foundation, 
or  additions,  etc. 

FIXED  ASSETS 

DEPRECIATION  RESERVE 

Detail 

Total 

Date 

Rate 

Annual 

Total 

Figure  22.    Plant  Ledger 

added  to  the  asset.  It  is  useful  to  have  them  entered  on  the 
plant  ledger  account  for  memorandum  purposes,  so  that  in 
making  future  estimates  it  will  be  possible  to  obtain  infor- 
mation of  the  past  costs  of  repairs,  not  only  in  total  but  also 
by  departments  and  by  units.  It  is  not  within  the  province 
of  this  discussion  to  treat  of  the  accounting  features  in- 
volved in  the  operation  of  a  plant  ledger,  but  it  is  necessary 


THE  PLANT  AND  EQUIPMENT  BUDGET 


255 


to  emphasize  its  usefulness  in  making  plans  for  the  control 
of  maintenance  cost. 

Figure  22  shows  a  typical  form  of  plant  ledger. 

Data  Calculated  from  Predetermined  Factors 

Later  chapters  will  show  that  the  various  departmental 
estimates  are  combined  for  two  purposes: 

1.  To  determine  the  estimated  cash  receipts  and  the  estimated  cash 

disbursements,  and  thereby  formulate  a  financial  budget. 

2.  To  determine  the  estimated  revenues  and  the  estimated  expenses, 

and  thereby  formulate  an  estimated  statement  of  profit  and 
loss. 

In  making  all  the  departmental  estimates,  it  should  be 
borne  in  mind  that  every  business  desires  to  formulate  a 
program  which  it  is  capable  of  financing  and  which  w^ill  re- 
sult in  the  greatest  possible  profit.  A  financial  budget  and 
the  estimated  statement  of  profit  and  loss  are  the  state- 
ments which  answer  the  two  questions  which  are  most  sig- 
nificant with  reference  to  the  budgetary  program.  And  all 
departmental  estimates  must  be  made  so  that  these  two 
statements  can  be  prepared.  In  the  preparation  of  the  es- 
timated statement  of  profit  and  loss,  the  periodical  deprecia- 
tion charge  is  an  important  factor.  Consequently  it  must 
be  given  careful  consideration  in  the  preparation  of  the 
plant  and  equipment  budget. 

All  equipment  wears  out  in  time  and  its  replacement 
must  be  provided  for.  This  provision  is  accomplished  by 
charging  a  certain  amount  to  the  expenses  of  each  budget 
period,  and  crediting  a  like  amount  to  a  reserve  for  depre- 
ciation. The  accounting  technique  involved  in  the  opera- 
tion of  such  a  reserve  account  need  not  be  dealt  with  here. 
It  is  sufficient  at  this  time  to  see  that  the  amount  of  such 
depreciation  is  an  important  element  of  the  expense  of 
operation  and  must  be  included  in  the  plant  and  equipment 


256 


BUDGETARY  CONTROL 


budget.  In  the  calculation  of  the  depreciation  charge,  three 
things  are  considered :  the  original  cost  of  the  asset,  its  antici- 
pated life,  and  its  estimated  scrap  value.  By  subtracting 
the  scrap  value  of  the  asset  from  its  original  cost,  it  is  possi- 
ble to  determine  the  cost  of  the  use  of  the  asset  during  its 
period  of  life.  This  cost  must  be  distributed  over  the  period 
of  its  life  in  such  a  way  that  each  budget  period  will  be 
charged  with  its  equitable  share. 

Distribution  of  Depreciation  Cost 

There  is  a  difference  of  opinion  as  to  how  this  cost  should 
be  distributed.  Some  contend  that  each  budget  period 
should  be  charged  an  equal  amount;  others  contend  that 
the  earlier  period  should  be  charged  more  than  the  later 
periods,  since  the  equipment  is  more  efficient  when  it  is  new 
and  the  cost  of  repairs  is  less,  while,  when  it  becomes  older, 
its  efficiency  decreases  and  the  cost  of  repairs  becomes 
greater.  Other  methods  are  also  suggested,  but  it  is  not 
thought  advisable  to  discuss  them  here.  Whatever  method 
of  determining  the  periodical  charge  is  used,  once  adopted 
it  should  be  followed  throughout  the  life  of  the  equipment. 

The  determination  of  the  periodical  charge  is,  therefore, 
merely  a  mathematical  calculation.  If  it  is  decided  to 
charge  each  period  a  uniform  amount,  it  is  only  necessary 
to  take  the  figures  of  past  periods  as  a  basis  of  the  present 
period  budget  charge.  If  some  other  method  is  followed, 
the  charge  for  the  current  period  may  be  more  or  less  than 
that  of  the  previous  period,  but  it  will  be  a  uniform  increase 
or  decrease  and  can  be  determined  by  a  consideration  of  the 
predetermined  factors  previously  mentioned. 

Effect  of  the  Budget  Program 

The  accounting  and  statistical  records  show  the  past 
expenditures  for  plant  and  equipment,  but  as  suggested  by 


THE  PLANT  AND  EQUIPMENT  BUDGET 


257 


the  preceding  discussion,  a  change  in  the  volume  of  produc- 
tion affects  both  the  maintenance  charges  and  the  charges 
for  additions  and  betterments.  It  is  necessary,  therefore, 
to  consider  the  effect  of  the  budget  program  on  each 
of  these. 

There  are  many  plans  which  may  affect  cost  of  mainte- 
nance. If  a  large  increase  in  production  is  planned,  the 
increased  cost  of  maintenance  arising  from  this  increased 
production  must  be  estimated.  If  new  methods  of  manu- 
facture are  to  be  employed,  the  consequent  change  in  main- 
tenance cost  must  be  calculated.  If  new  equipment  is  to 
take  the  place  of  old,  the  maintenance  cost  will  be  affected. 
If  it  is  planned  to  inaugurate  a  policy  of  keeping  the  equip- 
ment in  better  repair  so  as  to  make  it  more  efficient  and  to 
prolong  its  life,  this  change  must  be  considered.  These  as 
well  as  other  factors  affect  the  cost  of  maintenance,  and  all 
these  factors  must  be  considered. 

In  considering  the  relation  of  maintenance  cost  to  future 
plans,  various  comparisons  should  be  made.  This  is  due  to 
the  fact  that  some  items  of  maintenance  cost  will  vary  in 
proportion  to  certain  factors,  while  others  will  vary  in  pro- 
portion to  different  factors.  To  estimate  these,  it  is  neces- 
sary to  determine  the  ratio  of  the  volume  of  production  to 
these  costs  during  the  past  period  or  periods.  By  applying 
this  ratio  to  the  estimated  volume  of  production  for  the 
current  period,  an  estimate  of  these  items  of  maintenance 
expense  for  this  period  can  be  obtained.  Some  items  of 
maintenance  cost  will  vary  more  nearly  with  the  floor  space 
used  than  with  the  production  volume.  Therefore,  the 
ratio  of  floor  space  used  in  the  past  period  to  these  items  of 
maintenance  expense  during  the  same  periods  will  be  ob- 
tained, and  this  ratio  applied  to  the  estimated  floor  space  of 
the  current  period.  Other  items  of  maintenance  costs  may 
vary  in  proportion  to  the  number  of  units  of  equipment 

17 


258 


BUDGETARY  CONTROL 


which  are  used.  Hence  the  amount  of  these  items  will  be 
increased  as  the  number  of  the  units  of  equipment  are  in- 
creased. 

In  the  same  manner  in  which  the  general  plans  of  the 
business,  as  reflected  in  the  departmental  estimates,  affect 
the  cost  of  maintenance,  they  determine  the  amount  of  new 
equipment  to  be  purchased.  In  a  manufacturing  business 
the  amount  of  equipment  required  is  determined  primarily 
by  the  volume  of  production.  If  records  are  available 
which  show  machine  capacity,  such  as  were  discussed  in 
connection  with  the  production  budget,  it  is  not  difflcult  to 
estimate  the  requirements  of  the  increased  production  in 
terms  of  number  of  machines  or  units  of  equipment.  If 
proper  records  are  maintained,  it  is  possible  to  estimate  the 
total  requirements  of  the  production  program  and  the  total 
production  capacity  of  the  factory.  By  a  comparison  the 
excess  of  requirements  over  capacity  can  be  determined, 
and  from  this  the  new  equipment  required  can  be  calculated. 

Information  Obtained  by  the  Investigation  and  Study  of  Experts 

It  is  desirable  that  a  periodical  check  be  made  on  the 
accuracy  of  the  value  of  the  plant  and  equipment  as  shown 
by  the  records.  If  a  plant  ledger  is  maintained  in  the  form 
described  in  the  preceding  discussion,  it  is  possible  to  obtain 
the  original  cost,  the  accrued  depreciation,  and  the  repairs 
incurred  on  each  unit  of  plant  and  equipment.  The  depre- 
ciation shown  as  accrued  is  only  an  estimate,  however,  and 
the  expenses  which  have  been  incurred  may  have  been  more 
or  less  than  those  required  to  maintain  the  equipment  in  an 
efficient  condition.  Unless  some  steps  are  taken  to  deter- 
mine the  accuracy  of  the  estimated  depreciation  and  the 
sufficiency  of  the  repairs  which  have  been  made,  it  may  be 
determined  in  the  future  that  both  the  depreciation  and  the 
repairs  have  been  inadequate,  and  consequently  there  will 


THE  PLANT  AND  EQUIPMENT  BUDGET  259 


be  an  unduly  heavy  charge  against  the  earnings  of  future 
years. 

To  avoid  this  it  is  desirable  that  a  periodical  inventory 
or  appraisal  be  made  of  plant  and  equipment  and  used  as  a 
means  of  checking  the  plant  ledger  and  as  a  basis  for  budg- 
etary plans.  By  this  means  inaccuracies  in  depreciation 
estimates  and  inadequate  repairs  can  be  discovered  and 
corrected.  It  is  also  possible  that  too  liberal  depreciation 
may  be  allowed  or  too  extensive  repairs  are  being  made. 
Such  appraisals  will  serve  to  disclose  this.  They  will  also 
show  when  it  is  better  to  purchase  a  new  machine  rather 
than  repair  an  old  one. 

Although  an  appraisal  of  plant  and  equipment  is  quite 
valuable  to  use  in  the  way  indicated  in  the  preceding  para- 
graph, it  must  be  used  with  discretion,  especially  if  it  is 
made  by  professional  appraisers.  The  viewpoint  of  the 
professional  appraiser  is  not  always  that  of  the  accountant 
or  that  of  the  financial  executive.  The  appraiser  tries  to 
determine  the  present  value  of  the  article  he  is  appraising. 
He  is  concerned  with  its  original  cost  and  past  use,  only  as 
they  assist  him  in  determining  present  value.  As  a  con- 
sequence, market  fluctuations  are  apt  to  be  reflected  in  his 
appraisal.  The  accountant  and  financial  executive,  on  the 
other  hand,  are  not  interested  in  the  market  value  of  the 
equipment.  They  are  interested  only  in  apportioning  the 
original  cost  and  the  cost  of  repairs  over  the  periods  which 
will  benefit  from  its  use,  in  as  equitable  a  manner  as  possible. 
An  increase  in  the  market  value  of  the  asset  does  not  increase 
its  life  or  its  efficiency;  neither  does  a  decrease  in  its  market 
value  decrease  its  life  or  its  efficiency. 

Because  of  these  reasons,  the  value  of  the  appraiser  may 
not  agree  with  the  book  value,  and  yet  the  book  record  may 
be  satisfactory.  The  chief  importance  of  the  appraisal  is 
not  the  value  which  it  places  on  the  asset,  but  rather  the 


263 


BUDGETARY  CONTROL 


appraiser's  estimate  of  the  length  of  Hfe  and  efficiency  of 
the  asset  as  reflected  in  the  value  placed  on  it. 

The  Plant  Engineer 

Many  manufacturing  companies  have  on  their  staff  a 
plant  engineer,  who  is  responsible  for  the  production,  use, 
and  maintenance  of  plant  and  equipment.  As  indicative  of 
the  function  of  the  plant  engineer,  the  following  responsi- 
bilities may  be  mentioned : 

1.  The  study  of  improved  methods  of  factory  construction. 

2.  The  study  of  present  factory  layouts,  and  presentation  for  the 

approval  of  the  executive  in  charge  of  production,  of  proposals 
for  improvements  based  on  costs  involved  and  savings  made. 

3.  The  study  of  machinery,  equipment,  and  tools,  and  the  presenta- 

tion for  the  approval  of  the  executive  in  charge  of  production, 
of  proposals  for  changes,  based  on  costs  involved  and  savings 
to  be  made. 

4.  The  presentation  of  a  periodical  plant  and  equipment  program, 

based  on  studies  made  in  collaboration  with  the  works  plan- 
ning department  and  the  works  engineering  department. 

5.  The  presentation  of  the  plant  and  equipment  program  to  the 

executive  in  charge  of  production,  for  approval  and  transmis- 
sion to  the  budget  committee. 

6.  The  preparation  of  a  periodical  maintenance  program  as  prepared 

by  the  works  maintenance  department  and  detailed  by  the 
works  engineering  department. 

7.  The  presentation  of  the  maintenance  program  to  the  executive 

in  charge  of  production,  for  approval  and  transmission  to  the 
budget  committee. 

8.  The  supervision  over  the  execution  of  the  plant  and  equipment 

and  the  maintenance  programs  as  approved  by  the  budget 
committee. 

Where  there  is  an  efficient  plant  engineer  performing 
the  functions  suggested  in  the  above  outline,  the  services  of 
professional  appraisers  can  usually  be  dispensed  with  under 
normal  conditions. 


CHAPTER  XVII 


THE  PLANT  AND  EQUIPMENT  BUDGET 
(Continued) 

Preparation  of  Plant  and  Equipment  Budget 

The  preceding  discussion  explained  in  considerable 
detail  the  data  which  serve  as  a  basis  for  the  preparation  of 
the  plant  and  equipment  budget.  It  is  now  necessary  to 
see  how  these  data  are  formulated  into  a  budgetary  pro- 
gram which  serves  as  a  means  of  controlling  plant  and 
equipment  expenditures.    This  involves  a  consideration  of : 

1.  The  contents  of  the  plant  and  equipment  budget. 

2.  The  responsibility  for  its  preparation. 

3.  The  form  in  which  it  is  made. 

4.  The  manner  in  which  it  is  used. 

Contents  of  the  Plant  and  Equipment  Budget 

The  plant  and  equipment  budget  can  be  made  to  show 
any  information  which  the  executives  think  is  desirable  for 
their  use.  It  is  usually  thought  desirable  that  it  contain 
the  following : 

1.  The  value  of  present  equipment  at  the  beginning  of  the  period. 

2.  The  estimated  depreciation  and  repairs  on  present  equipment. 

3.  The  estimated  cost  of  new  equipment  which  should  show : 

(a)  Cost  of  factory  equipment,  and 

(b)  Cost  of  equipment  for  administrative  and  selling  units  of 

the  business. 

4.  Estimated  depreciation  and  repairs  on  new  equipment. 

5.  Total  depreciation  and  total  repairs  on  both  old  and  new  equip- 

ment. 

6.  Value  of  total  equipment  at  end  of  period. 

261 


262  BUDGETARY  CONTROL 

Responsibility  for  Preparation  of  Plant  and  Equipment  Budget 

The  executive  in  charge  of  production  is  responsible  for 
the  preparation  of  the  plant  and  equipment  budget  so  far 
as  it  relates  to  the  factory.  This  responsibility  he  will  dele- 
gate to  the  plant  engineer,  who  in  turn  will  employ  the 
assistance  of  the  works  maintenance  department  and  the 
works  engineering  department.  In  calculating  the  depre- 
ciation charges  he  will  avail  himself  of  the  services  of  the 
accounting  department  as  well.  The  cost  records  will  also 
be  of  service  in  estimating  the  cost  of  repairs  and  construc- 
tion of  new  equipment.  The  purchasing  department  will 
assist  in  estimating  the  cost  of  new  equipment  which  it  is 
planned  to  purchase. 

In  estimating  the  amount  of  equipment  required  it  is 
necessary  to  make  use  of  the  estimate  of  production,  since 
the  quantity  of  production  will  affect  the  equipment  re- 
quirements. If  a  plant  engineer  is  not  employed,  the  plant 
and  equipment  budget  may  be  prepared  by  the  staff  of  the 
production  manager  or  by  the  planning  department.  The 
cost  of  repairs  and  depreciation  will  be  estimated  by  the 
cost  accounting  department  in  the  estimate  of  manufactur- 
ing expense,  and  this  estimate  may  be  used  in  preparing  the 
estimate  of  plant  and  equipment,  but  it  is  preferable  that  a 
separate  estimate  be  prepared  by  some  unit  of  the  produc- 
tion department. 

The  office  manager  is  responsible  for  the  preparation  of 
the  estimate  of  equipment  for  the  administrative  and  selling 
units.  In  its  preparation  he  will  employ  the  assistance  of 
the  heads  of  the  departments  and  executive  units.  Each  of 
these  will  submit  a  request  to  the  office  manager  for  the 
equipment  which  he  desires  during  the  next  budget  period. 
The  office  manager  will  consolidate  these  into  one  estimate 
and  transmit  it  with  his  recommendations  to  the  executive 
in  charge  of  the  budgetary  procedure. 


THE  PLANT  AND  EQUIPMENT  BUDGET 


2 


Value 
of  Total 
Equipment 
at 

Period 

5  1 

Total 
Repairs 

(10) 

Total 
Deprecia- 
tion 

ET 

Estimated 
Repairs 

1 

I 

IT  BUDGI 

UIPMENT 

Estimated 
Deprecia- 
tion 

r  AND  EQUIPMEN 

NEW  EO 

When 
Needed 

CO 

New 
Equipment 
Required 

/ 

PLAN- 

1- 
z 

UJ 

Estimated 
Repairs 

D  EQUIPM 

Estimated 
Deprecia- 
tion 

5  ■ 

OL 

Amount 
at 

Beginning 
of 
Period 

CM 

GROUP 

/ 

3 


C 


C 


3 

Ml 


264 


BUDGETARY  CONTROL 


The  production  manager  will  transmit  the  estimate  of 
manufacturing  plant  and  equipment  to  the  executive  in 
charge  of  the  budgetary  procedure,  and  the  latter  will 
transmit  it  together  with  the  estimate  of  the  office  manager 
to  the  budget  committee.  After  the  committee  has  ap- 
proved these  estimates,  they  will  be  returned  to  the  pro- 
duction manager  and  the  office  manager,  respectively. 

Form  of  the  Plant  and  Equipment  Budget 

No  standard  form  for  the  plant  and  equipment  budget 
can  be  described,  for  its  form  will  depend  upon  the  method 
employed  in  its  preparation  and  use.  Figure  23  is  indicative 
of  the  information  that  the  budget  should  contain.  A  sep- 
arate form  may  be  used  for  factory  equipment  and  for  office 
equipment,  but  the  information  desired  in  the  two  cases 
is  sufficiently  similar  to  make  the  same  form  satisfactory 
in  most  cases. 

In  filling  in  columns  (4)  and  (8)  the  plant  engineer  will 
consult  the  works  engineering  department  with  reference 
to  the  cost  of  repairs.  The  works  maintenance  department 
will  supply  information  with  reference  to  the  amount  of 
repairs  to  be  made.  If  the  company  produces  its  equip- 
ment, the  works  engineering  department  will  supply  the 
data  needed  for  column  (5).  If  the  new  equipment  is  to 
be  purchased  from  outside  vendors,  the  purchasing  agent 
will  supply  these  data. 

Column  (6)  on  the  plant  and  equipment  budget  states 
when  the  new  equipment  is  desired.  With  this  as  a  basis 
the  purchasing  agent  will  state  the  terms  on  which  the  goods 
will  be  purchased  and  show  the  date  of  payment.  This 
information  is  necessary  for  the  preparation  of  the  financial 
budget.  If  the  equipment  is  to  be  produced  by  the  com- 
pany, an  estimate  must  be  made  of  the  disl)ursements 
necessary  for  its  production.    The  date  given  in  column  (6) 


THE  PLANT  AND  EQUIPMENT  BUDGET  265 

is  the  date  when  the  complete  equipment  is  desired.  It 
may  require  a  considerable  period  of  time  for  its  production. 
During  the  process  of  its  construction  expenditures  for 
labor  and  possibly  for  materials  will  need  to  be  made. 
Under  such  circumstances,  the  estimated  expenditures  pre- 
ceding the  completion  of  the  equipment  must  be  determined 
and  allocated  to  the  proper  period  for  the  purpose  of  the 
financial  budget. 

Execution  of  the  Plant  and  Equipment  Budget 

The  budget  for  plant  and  equipment  consists  of  an  esti- 
mate of  the  expenditures  necessary  for  maintaining  the 
present  equipment  and  the  securing  and  maintenance  of 
the  additional  equipment  demanded  by  the  budget  program. 
Its  approval  is  followed  by  the  making  of  various  appropria- 
tions for  the  necessary  amount  to  cover  the  cost  of  the  vari- 
ous items  included  in  the  budget.  After  these  appropria- 
tions are  made,  it  is  necessary  to  establish  a  procedure  which 
will  effect  their  enforcement.  This  procedure  usually 
requires  the  following: 

1.  That  expenditures  under  any  appropriation  be  made  only  after 

requisitions  for  these  expenditures,  accompanied  by  proper 
estimates  of  cost,  have  been  submitted  and  approved  by  the 
proper  authority. 

2.  That  careful  costs  be  kept  on  all  work  done  under  appropriations. 

3.  That  reports  be  prepared  showing  a  comparison  between  the 

estimated  and  actual  cost  of  all  such  work  performed. 

4.  That  reports  be  prepared  monthly  showing  the  status  of  all 

appropriations. 

Requisitions  for  Expenditures 

It  is  customary  to  delegate  to  some  official  of  the  com- 
pany the  authority  to  grant  expenditures  under  each  ap- 
propriation. In  many  cases  the  expenditures  are  divided 
into  two  groups,  known  as  "minor"  and  "major."  For 


266 


BUDGETARY  CONTROL 


instance,  any  expenditure  of  less  than  $ioo  may  be  termed 
a  "minor"  expenditure,  and  any  expenditure  of  more  than 
$ioo  may  be  termed  a  "major"  expenditure.  Tliehead  of 
the  production  department  may  be  given  the  authority  to 
approve  all  minor  expenditures  for  the  production  de- 
partment, and  the  office  manager  to  approve  all  minor 
expenditures  of  the  other  departments.  For  the  major 
expenditures  the  approval  of  the  budget  committee  may  be 
required. 

That  the  proper  executives  may  exercise  effective  con- 
trol over  the  disbursements  made  under  appropriations,  it 
is  necessary  that  the  disbursements  be  made  only  as  a  result 
of  a  requisition  or  request  on  the  part  of  the  one  desiring 
that  repairs  be  made  or  additional  equipment  secured. 
When  repairs  or  additions  to  plant  or  equipment  are  desired 
by  any  department,  the  head  of  this  department  should 
transmit  a  requisition  to  the  production  manager  or  the 
office  manager,  as  the  case  may  be. 

Such  requests  should  be  accompanied  by  an  estirnate  of 
the  cost  of  the  repairs  or  additions.  If  equipment  is  to  be 
purchased  from  outside  vendors,  it  is  easy  to  obtain  the 
purchase  cost  and  submit  it  with  the  requisition.  If  addi- 
tions to  plant  or  equipment  are  to  be  constructed  by  the 
company,  an  estimate  of  the  cost  of  the  construction  must 
be  made. 

The  estimate  of  the  cost  of  repairs  or  construction  which 
is  to  be  done  by  the  company  can  be  made  in  two  ways. 
If  the  business  maintains  an  engineering  department,  this 
department  can  be  asked  to  make  an  estimate.  A  compe- 
tent engineer  learns  by  experience  to  estimate  costs  accu- 
rately. His  estimates  should  be  checked  by  statistics  of  past 
costs.  If  it  is  not  possible  or  not  desirable  to  have  engineers 
make  the  estimate,  it  can  be  made  by  the  cost  accounting 
department,  which  will  make  the  estimate  on  the  basis  of 


THE  PLANT  AND  EQUIPMENT  BUDGET  267 

the  statistics  obtained  from  the  records  of  previous  costs. 
These  estimates  may  be  erroneous  if  the  one  making  them 
is  not  trained  in  mechanics.  If  cooperation  between  the 
accounting  department  and  the  engineering  department  is 
secured,  more  accurate  estimates  will  be  obtained. 

Costs  of  Construction  and  Repairs 

If  the  requisition  calls  for  construction  of  repairs  or 
equipment  by  the  factory,  there  should  be  careful  records 
kept  of  the  cost  of  the  construction.  The  method  of  de- 
termining these  costs  is  very  similar  to  the  method  of 
determining  the  cost  of  goods  manufactured  for  sale. 
Each  requisition,  after  it  has  been  approved,  is  given  a 
number,  and  a  construction  order  is  issued  authorizing  the 
construction  called  for  by  the  requisition.  The  construc- 
tion order  has  the  same  number  as  the  requisition.  An 
account  is  opened  on  the  cost  records  for  the  construction 
order  and  all  costs  incurred  in  the  construction  are  charged 
to  this  account. 

It  must  be  remembered  that  in  arriving  at  the  cost  of 
construction  a  business  cannot  derive  a  profit  from  work 
done  for  itself.  Hence  no  profit  must  be  allowed  on  con- 
struction work  performed  by  the  company  for  itself.  It 
may  be  possible  that  the  company  performs  this  work  for 
less  than  it  can  secure  it  from  outsiders.  This  results  in  a 
saving  to  the  company,  but  it  does  not  result  in  a  profit. 

Reports  on  Construction  Costs 

When  a  construction  order  is  completed,  a  report  is 
made  to  the  executive  having  supervision  over  the  expendi- 
tures for  construction,  showing  the  estimated  cost  and  the 
actual  cost.  If  there  is  any  considerable  variance,  it  is 
due  to  inaccurate  estimates  or  excessive  cost.  With  the 
comparative  figures  available  it  is  possible  to  determine  the 


268 


BUDGETARY  CONTROL 


cause  of  the  variation.  Unless  such  comparisons  are  made, 
it  is  impossible  to  exercise  any  effective  control  over  the 
cost  of  construction  work. 

A  copy  of  these  reports  should  go  to  the  controller  or 
head  accountant,  as  well  as  to  the  production  manager  and 
budget  committee.  This  procedure  will  provide  a  com- 
prehensive check  on  the  costs  of  construction. 

Report  on  Appropriations 

To  exercise  effective  control  over  the  plant  and  equip- 
ment budget,  it  is  necessary  to  have  periodical  reports 
which  will  make  possible  a  comparison  between  the  amount 
appropriated  for  each  class  of  expenditures  and  the  actual 
amount  expended.  A  report  should  be  made  monthly, 
giving  this  comparison.  This  report  should  provide  the 
information  shown  in  Figure  24. 

A  report  made  in  this  form  is  of  service  not  only  to  the 
executive  who  is  exercising  control  over  the  purchases  and 
construction  of  plant  and  equipment,  but  also  to  the  finan- 
cial executive.  It  shows  the  former  the  amount  which  he 
has  available  for  future  construction,  and  the  latter  the 
amount  which  he  must  plan  to  finance.  The  tenth  column 
gives  the  treasurer  information  of  special  value,  since  it 
states  the  payments  which  must  be  made  in  the  near  future. 
Column  (13)  shows  the  amount  which  may  be  diverted  to 
some  other  purpose  in  case  of  financial  stringency.  If  the 
budget  committee  receives  this  report  each  month,  it  can 
exercise  an  effective  control  over  all  disbursements  for  plant 
and  equipment. 

Reserve  for  Contingent  Expenditures 

It  is  usually  not  possible  to  estimate  exactly  each  item 
of  plant  and  equipment  cost  which  must  be  met  during  the 
budget  period.    There  will  usually  be  need  for  expenditures 


THE 


PLANT  AND  EQUIPMENT  BUDGET 


269 


C70 


BUDGETARY  CONTROL 


which  cannot  be  foreseen.  It  is  desirable  to  anticipate 
these  additional  costs  and  include  an  item  in  the  plant  and 
equipment  budget  of  each  period  to  cover  them.  Since 
these  additional  costs  vary  in  amount  from  period  to  period, 
it  is  well  to  credit  a  reserve  account  for  the  amount  provided 
for  them  in  each  budget.  When  the  costs  are  incurred,  they 
can  be  charged  against  the  reserve.  These  additional  costs 
may  be  due  to  rising  costs  of  material  and  equipment,  labor 
emergencies,  accidents,  increased  production,  and  similar 
causes. 

By  employing  the  method  outlined  above,  these  costs 
can  be  taken  care  of  when  they  arise.  It  is  obvious  that 
this  reserve  has  a  limited  use  and  must  not  be  used  as  a 
means  of  hiding  excessive  amounts  paid  for  construction  or 
repairs  during  certain  periods.  If  it  is  too  large,  it  prevents 
the  control  being  exercised  for  which  the  plant  and  equip- 
ment budget  is  intended. 

Use  of  Standardized  Equipment 

There  is  a  modern  tendency  to  use  standardized  equip- 
ment throughout  a  business.  Such  standardization  is 
especially  desirable  for  furniture,  fixtures,  and  office  equip- 
ment. To  that  end  businesses  frequently  select  a  standard 
type  of  desk,  standard  typewriters,  and  standard  calculat- 
ing machines  to  be  used  in  all  offices.  Any  other  type  of 
equipment  which  is  in  general  use  should  be  standardized, 
if  possible.  Factory  equipment  should  be  standardized  if 
practicable. 

There  are  several  advantages  in  having  standardized 
equipment,  among  which  the  following  may  be  mentioned : 

I.  By  buying  all  equipment  from  one  company,  it  may  be  possible 
to  obtain  more  favorable  terms.  At  least  such  buying  pre- 
vents the  purchasing  of  unduly  expensive  equipment  by  some 
departments  when  less  expensive  equipment  would  do  as  well. 


THE  PLANT  AND  EQUIPMENT  BUDGET 


271 


2.  It  facilitates  the  purchasing  of  new  equipment,  since  a  requisi- 

tion can  be  made  for  one  unit  of  equipment  and  sent  to  the 
general  purchasing  agent  who  knows  what  to  purchase,  from 
whom  to  purchase,  and  the  cost  of  the  same.  This  eliminates 
the  preparation  of  specifications  for  the  use  of  the  purchasing 
agent  and  relieves  him  of  the  task  of  obtaining  quotations  on 
special  types  of  equipment. 

3.  It  facilitates  the  production  of  equipment  which  the  company 

produces  for  its  use,  since  standard  specifications  can  be 
prepared  and  the  necessary'  materials  and  tools  can  be  pro- 
cured in  advance.  It  also  facilitates  the  making  of  repairs, 
since  piece  parts  can  be  kept  on  hand,  and  mechanics  will 
become  more  skilled  in  making  repairs. 

4.  It  facilitates  future  planning,  for  it  is  only  necessary'  to  estimate 

the  number  of  units  required  and  the  cost  can  be  easily 
obtained. 

5.  It  tends  to  promote  the  most  economical  use  of  equipment,  since 

equipment  can  be  moved  from  one  office  or  one  department  to 
another,  thus  preventing  a  probable  surplus  in  one  and  a 
shortage  in  another. 

6.  In  case  of  equipment  which  requires  technical  skill  to  operate, 

it  facilitates  the  transfer  of  employees  from  one  department  to 
another. 

Review  and  Summary 

In  the  preceding  pages,  the  procedure  necessary  for  the 
preparation  and  execution  of  the  plant  and  equipment 
budget  has  been  outlined.  In  summary  form,  this  proce- 
dure is  as  follows: 

I.  Requirements  for  Control  of  Plant  and  Equipment: 

1.  A  proper  analysis  of  plant  and  equipment  expenditures  to 

determine  their  classification  and  a  record  of  them  which  will 
show  correctly  their  eff"ect  on  the  financial  condition  of  the 
business. 

2.  A  proper  control  of  the  amount  expended  for  plant  and  equip- 

ment to  the  end  that  sufficient  will  be  expended  to  provide  a 


'  In  this  brief  summary  no  attempt  is  made  to  indicate  the  organization  necessary  for  plant 
and  equipment  control,  this  having  been  discussed  in  the  preceding  pages. 


272 


BUDGETARY  CONTROL 


well-equipped  and  efficient  plant,  and  at  the  same  time  pre- 
vent the  expenditures  of  more  than  is  necessary  to  secure  this 
result. 

II.  Control  of  the  Amount  of  Expenditures  Required: 

1.  That  data  be  available  which  will  show  results  of  past  operations 

and  serve  as  the  basis  of  future  plans.. 

2.  That  plans  be  formulated  on  the  basis  of  these  data  and  be  ex- 

pressed in  workable  form  by  means  of  a  plant  and  equipment 
budget. 

3.  That  records  be  maintained  and  reports  be  made  which  make 

possible  the  enforcement  of  the  budget  formulated. 

III.  Data  Required  as  Basis  of  Control: 

1.  Those  which  are  obtained  from  the  accounting  and  statistical 

records  with  reference  to  past  experience. 

2.  Those  which  are  obtained  by  mathematical  calculations  based 

on  predetermined  factors. 

3.  Those  which  are  determined  by  a  consideration  of  future  plans. 

4.  Those  which  are  obtained  as  a  result  of  the  investigation  and 

study  of  experts. 

IV.  Plant  and  Equipment  Budget  Shows: 

1.  The  anticipated  repairs  and  estimated  depreciation  on  the  pres- 

ent plant  and  equipment. 

2.  The  estimated  cost  of  new  equipment  including  (a)  cost  of  factory 

equipment,  and  (b)  cost  of  equipment  for  administrative  and 
selling  units. 

3.  The  anticipated  repairs  and  estimated  depreciation  on  the  new 

equipment  to  be  secured. 

V.  Records  and  Reports  fox  Control  of  Plant  and  Equipment 
Budget  Include: 

1.  Requisitions  for  all  purchases  of  equipment  and  for  all  construc- 

tion of  equipment  or  repairs. 

2.  Estimates  of  cost  of  purchases  or  construction  which  accompany 

the  requisitions. 

3.  Records  of  the  cost  of  all  construction  or  repair  work  performed 

by  the  company. 

4.  Reports  showing  a  comparison  of  estimates  and  costs. 

5.  Reports  showing  a  comparison  of  expenditures  with  budget 

allotments. 


CHAPTER  XVIII 


THE  EXPENSE  BUDGETS 

The  Expense  Problem 

In  the  operation  of  a  business  it  is  necessary  to  incur  nu- 
merous expenditures  which  in  accounting  and  business 
practice  are  designated  by  the  general  term  "expenses." 
Expenses  are  incurred  in  connection  with  the  operations  of 
all  the  functional  departments  of  a  business.  In  the  secur- 
ing of  sales,  expenses  are  incurred  for  salaries  of  salesmen, 
wages  of  clerical  help,  postage,  stationery,  supplies,  and 
advertising.  In  the  production  of  goods,  heat,  light,  power, 
supplies,  and  miscellaneous  labor  must  be  purchased.  In 
the  maintenance  of  plant  and  equipment,  repair  and  replace- 
ment costs  must  be  borne.  In  the  general  administration 
of  the  business,  expenses  of  various  kinds  are  necessary. 

Although  many  expenses  are  incurred  in  small  amounts, 
the  sum  total  of  all  expenses  in  most  businesses  is  sufficiently 
large  to  absorb  a  large  percentage  of  the  returns  from  sales. 
The  amount  of  the  expenses  of  a  business  is  apt  to  deter- 
mine whether  it  operates  at  a  profit  or  a  loss.  Its  sales  and 
its  purchases  are  presumably  made  in  a  competitive  market 
where  it  has  the  same  advantages  as  its  competitors.  In  so 
far  as  this  is  true,  the  gross  profit  of  competing  businesses 
should  tend  to  be  the  same.  But  the  expense  element  in 
different  businesses  varies  widely,  and  in  this  fact  lies  to  a 
large  extent  the  explanation  of  the  wide  variations  in  the 
net  profits. 

Because  expenses  are  incurred  by  all  departments  of  a 
business,  are  largely  intangible  in  nature,  and  the  individual 
items  are  small,  their  control  is  difficult.  They  have  a 
tendency  to  increase  constantly,  and  as  they  increase,  the 

18  273 


274 


BUDGETARY  CONTROL 


profits  of  the  business  tend  to  decrease.  To  secure  a  con- 
trol of  expenses  which  is  effective  and  yet  not  unduly  burden- 
some is  one  of  the  most  important  and  difficult  tasks  of 
business  management. 

Classification  of  Expenses 

■  One  of  the  first  steps  in  effecting  a  proper  control  of 
expenses  is  the  establishment  of  a  proper  classification  or 
grouping  of  them.  It  is  obvious  that  administrative  atten- 
tion cannot  be  given  to  each  separate  item  of  expense,  and 
this  fact  necessitates  that  a  classification  be  made  which 
will  make  possible  the  focusing  of  executive  attention  on 
groups  of  related  items. 

Expenses  may  be  classified  in  many  ways,  depending  on 
the  purpose  for  which  the  classification  is  to  be  used.  From 
the  viewpoint  of  administrative  control  the  following  classi- 
fication is  helpful: 

1.  Manufacturing  expenses,  or  those  which  are  incurred  in  the  oper- 

ation of  the  factory  and  the  production  of  the  commodity  or 
service  which  is  offered  for  sale. 

2.  SeUing  expenses,  or  those  which  are  incurred  in  the  marketing  of 

the  product  produced  or  purchased  for  sale. 

3.  Financial  expenses,  or  those  incurred  in  planning  and  controlling 

the  receipt,  custody,  and  disbursement  of  funds. 

4.  Auxiliary  expenses,  or  those  incurred  by  the  various  auxiliary  or 

"service"  departments  of  the  business,  such  as  the  accounting 
department,  personnel  department,  purchasing  department, 
and  office  manager's  department. 

5.  Executive  expenses,  or  those  which  are  incurred  in  the  general 

administration  of  the  business  and  cannot  be  charged  to  any 
of  the  foregoing  groups.  This  group  includes  the  expenses  of 
the  general  manager  and  his  staff. 

6.  Corporate  expenses,  or  those  which  are  not  incurred  as  a  result  of 

the  operations  of  any  particular  department,  but  which  are 
necessary  that  the  business  exist  and  operate  as  an  entity. 
Directors'  fees  and  expenses,  capital  stock  tax,  and  income 
taxes  are  illustrations  of  such  expenses. 


1 


THE  EXPENSE  BUDGETS 


275 


This  classification  is  different  both  in  grouping  and 
terminology  from  the  usual  accounting  classification  of 
expenses.  The  reasons  for  these  differences  will  be  explained 
when  each  class  of  expense  is  discussed. 

Relation  of  Expense  Classification  to  Form  of  Organization 

The  foregoing  classification  of  expenses  will  be  more 
readily  seen  if  it  is  considered  in  connection  with  the  chart  of 


STAFf  ASSISTAHT 
IN  CHAR4C  OF 

BUDGETARY 
PROGRAM 

PRESIDENT 

AND 

GENERAL  MANAGER 

STAFF  ASSISTAKI 
TO 

PRESIOCNT 

VICE-PRESIDENT 

IN  CHARGE  or 

PRODUaiON 


VICE-PRESIDENT 
IN  CHARoe  or 
OPERATIONS 


VICE-PRESIDENT 

IN  CHARGE  or 

SALES 


VICE-PRESIDENT 
IN  CHARcc  or 
FINANCE 


General 
Auditor 


Personnel 
Manager 


PuTchasmg 
Agent 


Office 
Manager 


Credit 
Manager 


Cashier 


Figure  25.    Organization  Chart  for  a  Manufacturing  Business 

a  typical  organization  of  a  manufacturing  business  which  is 
shown  in  Figure  25. 

It  will  be  understood  that  the  chart  of  organization 
shown  in  Figure  25  is  intended  to  be  suggestive  and  not 
arbitrary.  Scarcely  any  two  businesses  will  have  the  same 
plan  of  organization.  This  is  due  to  the  differences  in  size, 
volume,  nature  of  operations,  and  nature  of  personnel.  In 
a  mercantile  business  a  merchandise  department  will  take 
the  place  of  the  production  department  showiiinthe  illustra- 
tion. In  many  businesses  there  will  not  be  a  vice-president 
in  charge  of  operations  to  which  some  of  the  auxiliary  de- 
partments report.    Where  the  administration  of  personnel 


276 


BUDGETARY  CONTROL 


is  regarded  as  a  major  function,  the  personnel  manager  may 
be  given  a  more  prominent  position  than  is  indicated  in  this 
chart.  If  the  standards  and  record  function  is  developed 
properly,  there  may  be  a  controller  who  will  combine  under 
his  jurisdiction  several  of  the  functions  given  in  the  fore- 
going chart. 

A  form  of  organization  which  the  author  thinks  is  pref- 
erable to  that  given  in  Figure  25  is  shown  in  Figure  26. 
The  less  preferable  form  is  used  as  a  basis  for  this  discussion 
for  it  more  nearly  corresponds  to  the  situation  found  in 
most  medium-sized  businesses.  The  primary  purpose  of 
introducing  a  chart  of  organization  at  this  time  is  to  indicate 
the  desirability  of  classifying  expenses  to  correspond  with 
the  classification  of  administrative  activities  maintained  by 
a  business  as  shown  by  its  chart  of  organization.  The 
significance  of  this  method  of  classification  will  be  more 
apparent  as  the  discussion  proceeds. 

Direct  and  Indirect  Expenses 

There  are  some  expenses  which  are  incurred  for  the 
benefit  of  only  one  department,  and  these  can  be  charged 
directly  to  that  department.  For  instance,  the  salaries  of 
the  sales  clerks  can  be  connected  directly  with  the  opera- 
tions of  the  sales  department  and  charged  to  selling  expense. 
The  repairs  on  factory  equipment  can  be  connected  directly 
with  the  operations  of  the  production  department  and 
charged  to  manufacturing  expenses.  These  are  known  as 
"direct"  expenses. 

There  are  other  expenses  which  are  incurred  for  the 
benefit  of  two  or  more  departments  and  which  cannot  be 
charged  directly  to  the  expenses  of  any  one  department. 
For  instance,  the  expenditures  for  light  and  heat  are  for  tha 
benefit  of  all  the  departments  of  a  business.  It  is  neces- 
sary to  allocate  these  expenditures  to  the  various  depart- 


THE  EXPENSE  BUDGETS 


277 


278 


BUDGETARY  CONTROL 


ments  which  are  benefited  by  them.  These  are  known  as 
"indirect"  expenses. 

The  expenses  which  are  here  termed  indirect  expenses  are 
referred  to  by  various  names  by  writers  and  practitioners. 
They  are  called  "overhead,"  "burden,"  "non-productive," 
and  by  other  terms.  The  terminology  of  accounting  and 
business  management  is  not  standardized.  It  is  impossible 
to  use  terms  which  have  a  uniform  meaning  and  usage. 
The  most  that  can  be  done  is  to  define  clearly  those  used 
and  to  limit  their  use  to  the  definition  given. 

Allocation  of  Indirect  Expenses 

In  most  businesses  the  indirect  expenses  are  of  sufficient 
amount  to  make  their  allocation  a  matter  of  major  impor- 
tance if  a  proper  classification  of  expenses  is  to  be  main- 
tained, and  accountants  and  industrial  engineers  have 
given  much  thought  to  this  problem  of  allocation.  Two 
questions  arise  from  a  consideration  of  the  problem : 

1.  What  expenses  should  be  allocated  and  to  what  departments? 

2.  On  what  basis  should  the  allocation  be  made? 

In  answering  the  first  question  it  is  necessary  to  consider  the 
purpose  for  which  the  allocation  is  being  made;  or  to  carry 
the  inquiry  one  step  farther,  it  is  necessary  to  know  for 
what  purpose  the  data  with  reference  to  expenses  are  to  be 
used. 

Allocation  of  Manufacturing  Expenses 

Most  of  the  discussion  of  allocation  of  indirect  expenses 
in  the  past  has  dealt  with  the  allocation  of  manufacturing 
expenses  to  classes  of  product,  or  to  specific  "  jobs  "  or  order 
lots.  The  purpose  of  this  allocation  is  to  obtain  unit  costs. 
The  problem  here  is  one  of  intra-departmental  distribution. 
It  is  a  question  of  distributing  the  total  manufacturing  ex- 
penses over  the  total  product  produced  so  that  each  unit  of 


THE  EXPENSE  BUDGETS 


279 


the  product  will  bear  its  proportionate  part  of  these  expenses. 
Sufficient  consideration  is  given  to  this  problem  in  the  chap- 
ter on  the  manufacturing  expense  budget. 

There  is  some  question  as  to  what  should  be  included 
under  manufacturing  expenses,  but  this  is  not  very  im- 
portant. Because  of  the  attention  given  to  factory  costs 
during  the  past  few  years,  which  has  led  to  a  careful  consid- 
eration of  what  elements  should  be  included  in  the  determi- 
nation of  those  costs,  there  has  developed  a  fairly  uniform 
opinion  as  to  what  expenses  should  be  classified  as  manu- 
facturing expenses.  There  are  some  items,  such  as  interest 
on  investment  and  rent,  which  are  yet  the  subject  of  con- 
troversy. 

Allocation  of  Commercial  Expenses 

Until  recently  there  has  been  little  attempt  to  apply  the 
principles  of  costs,  as  developed  in  connection  with  produc- 
tion, to  the  determination  of  selling  or  "administrative" 
costs.  There  has  been  much  attention  given  to  the  unit 
cost  to  produce,  but  little  attention  given  to  the  unit  cost  to 
market  or  the  unit  cost  of  "administration."  There  are 
certain  inherent  difficulties  which  make  the  determination 
of  such  unit  costs  quite  difficult,  and  in  some  cases  there  may 
be  doubt  of  their  usefulness. 

As  a  consequence  of  the  failure  to  develop  "commercial " 
costs,  there  has  been  much  less  attention  given  to  the  classi- 
fication of  "commercial"  or  non-manufacturing  expenses, 
than  has  been  given  to  the  distinction  between  manufac- 
turing and  non-manufacturing  expenses. 

Usually  the  "commercial "  expenses  which  represent  the 
difference  between  gross  profit  on  sales  and  net  operating 
profit,  are  grouped  under  the  two  general  headings  of  "sell- 
ing" and  "administrative."  All  items  which  are  not  clearly 
selling  expense  are  usually  placed  under  administrative 


28o 


BUDGETARY  CONTROL 


expense.  In  case  of  doubt  with  reference  to  any  particular 
item,  it  is  placed  in  the  latter  group  which  consequently 
comes  to  contain  a  great  many  items  of  a  miscellaneous 
nature.  Subclasses  may  be  maintained  under  each  of  the 
major  groups  of  selling  and  administrative  expense,  but 
usually  no  great  care  is  exercised  in  the  allocating  of  expenses 
between  the  subclasses. 

As  a  consequence  of  these  practices,  there  has  been  a 
decided  tendency  to  slight  the  question  of  allocating  indirect 
commercial  expenses.  When  such  allocation  has  been  made, 
it  has  frequently  been  on  an  unscientific  basis.  Depart- 
ment stores  and  some  few  other  businesses  have  broken 
away  from  the  traditional  policy  and  given  careful  consid- 
eration to  the  allocation  of  these  expenses,  but  such  a  prac- 
tice has  been  the  exception  rather  than  the  rule. 

Relation  of  Expense  Allocation  to  Organization  of  Business 

It  can  be  seen  from  the  foregoing  discussion,  that  the 
consideration  of  expense  allocation  has  been  confined  largely 
to  manufacturing  expenses  and  has  here  been  limited  in  the 
main  to  a  consideration  of  their  allocation  as  a  basis  for 
unit  costs.  Unit  costs  are  useful  and  desirable,  but  in  the 
desire  to  obtain  them  there  has  sometimes  been  a  tendency 
to  overlook  one  of  the  important  purposes  of  cost  statistics. 
It  is  not  sufficient  to  know  what  costs  are — in  addition  it  is 
necessary  to  control  costs  so  that  they  will  be  as  small  as 
possible. 

In  the  modern  business  organization,  control  is  exercised 
through  individuals  who  compose  the  organization.  If  con- 
trol of  expenses  is  to  be  effected  through  members  of  the 
organization,  it  is  necessary  that  they  be  classified  so  as  to 
show  the  responsibility  for  each  class.  If  responsibility  is 
taken  as  the  controlling  factor  in  an  expense  classification, 
each  department  will  be  charged  with  those  expenses  over 


THE  EXPENSE  BUDGETS 


281 


which  the  executive  head  of  the  department  exercises  con- 
trol. In  addition  it  may  be  charged  with  some  items  of 
expense  the  amount  of  which  is  fixed  or  at  least  is  beyond 
the  control  of  any  officer. 

To  illustrate,  the  production  department  will  be  charged 
for  the  supplies  used  in  production,  for  these  are  under  the 
control  of  the  production  manager,  and  in  addition  it  will  be 
charged  with  the  depreciation  on  production  equipment, 
the  estimated  amount  of  which  is  determined  in  most  cases 
by  others  than  the  production  manager.  The  depreciation 
should  be  treated  as  a  manufacturing  expense,  for  it  is  a 
direct  result  of  the  operations  of  the  production  department 
and  is  necessary  to  the  proper  performance  of  the  produc- 
tion function.  The  production  manager  could  not  affect  its 
amount  if  the  duty  of  determining  it  was  left  to  him,  for  its 
amount  is  determined  by  definite  factors  such  as  cost,  scrap 
value,  and  estimated  life. 

Expenses  Which  Should  Not  Be  Allocated 

As  an  illustration  of  the  type  of  expenses  which  it  seems 
better  not  to  allocate  to  a  department,  the  salaries  and 
expenses  of  the  president  and  his  staff  may  be  mentioned. 
It  is  sometimes  contended  that  as  the  president  supervises 
and  directs  all  the  departments  of  a  business,  his  salary  and 
that  of  his  staff  should  be  allocated  to  the  functional  depart- 
ments. For  instance,  a  portion  of  these  expenses  should 
be  charged  to  selling  expense.  It  seems  that  such  a  policy 
is  unwise,  since  such  salaries  are  variable  amounts,  subject 
to  the  wishes  of  the  president  and  the  board  of  directors  and 
are  not  directly  or  indirectly  under  the  control  of  the  sales 
department.  If  these  salaries  are  increased,  the  sales  ex- 
pense will  be  increased  and  the  sales  manager  is  powerless  to 
prevent  it. 

The  author  can  recall  one  case  in  which  the  compensa- 


282 


BUDGETARY  CONTROL 


tion  of  the  sales  manager  was  affected  by  the  ratio  of  selling 
expense  to  sales.  After  the  passage  of  the  income  and 
excess  profits  tax  law  of  191 7,  the  corporation  increased  the 
salaries  of  some  of  its  executives.  The  corporation  is  a 
close  one  and  certain  of  the  executives  are  the  principal 
stockholders.  Large  salaries  were  thought  to  be  better 
than  large  profits.  The  sales  manager  had  put  forth  an 
unusual  effort  to  increase  his  sales  for  the  year  1918  with 
unexpected  success.  But  when  the  increased  salaries  had 
been  allocated  to  the  departments,  the  sales  expense  was  so 
increased  that  the  bonus  of  the  sales  manager  was  smaller 
than  the  year  previous,  despite  the  unprecedented  increase 
in  sales. 

It  is  admitted  that  the  foregoing  is  an  extreme  case,  but 
it  illustrates  an  important  principle.  If  a  department  is 
charged  with  variable  expenses  over  which  its  executive 
head  and  his  assistants  have  no  control,  the  value  of  the 
departmental  expense  reports  as  a  basis  of  administrative 
control  is  largely  destroyed.  Expenses,  like  sales,  produc- 
tion, and  purchases  can  be  adequately  controlled  only  when 
estimates  are  made  by  those  responsible  for  their  amount 
and  these  held  responsible  for  the  attainment  of  these  esti- 
mates. Such  a  procedure  is  greatly  weakened  if  executives 
are  held  responsible  for  expenses  over  which  they  do  not 
exercise  control. 

The  first  question  asked  with  reference  to  expense 
allocation  may  be  answered  by  saying  that  no  expense 
should  be  allocated  to  a  department  if  such  allocation 
will  affect  in  a  material  way  the  fixing  of  responsibility 
for  the  expenses  of  the  department  on  its  executive  head. 
There  are  of  course  cases  where  expediency  will  dictate 
a  variation  from  the  application  of  the  general  principle, 
but  such  variations  should  be  permitted  only  for  good 
reasons. 


THE  EXPENSE  BUDGETS 


283 


Basis  of  Allocating  Expenses 

With  reference  to  the  basis  of  allocation,  it  is  beyond  the 
province  of  this  discussion  to  enter  into  any  detailed  dis- 
cussion of  this  question.  Cost  accountants  have  given  much 
consideration  to  the  allocation  of  manufacturing  expenses 
to  factory  departments  and  manufacturing  orders.  The 
reader  will  find  in  the  standard  works  on  cost  accounting 
able  discussions  of  the  various  methods  employed.  Much 
less  attention  has  been  given  to  the  proper  basis  for  the  allo- 
cation of  commercial  expense,  although,  as  already  stated, 
considerable  has  been  done  in  this  connection  by  depart- 
ment stores. 

The  factory  cost  accountant  in  the  early  development  of 
factory  costs  found  the  easiest  method  of  distributing  manu- 
facturing expenses  to  be  on  the  basis  of  direct  labor.  In  a 
similar  manner  the  mercantile  cost  accountant  found  the 
easiest  method  of  distributing  commercial  expenses  to  be  on 
the  basis  of  sales.  Consequently,  sales  have  been  used  very 
extensively  by  department  stores  as  a  basis  for  allocating 
expenses  to  the  various  departments  of  the  store.  But  the 
factory  cost  accountant  has  found  that  the  distribution  of 
expenses  on  the  basis  of  labor  olten  gives  incorrect  results, 
and  the  commercial  cost  accountant  has  found  that  the 
distribution  of  commercial  expenses  on  the  basis  of  sales 
may  give  results  equally  unsatisfactory. 

To  illustrate,  one  of  the  largest  items  of  expense  to  be 
allocated  in  a  department  store  is  advertising.  Formerly 
the  usual  method  of  allocating  this  to  the  various  depart- 
ments of  the  store  was  on  the  basis  of  sales.  This  practice 
leads  to  two  undesirable  results.  First,  some  departments 
profited  much  more  than  others  by  the  advertising,  since  it 
was  devoted  to  articles  sold  by  some  departments  much 
more  than  to  articles  sold  by  other  departments.  For  in- 
stance, the  advertising  of  ladies'  ready-to-wear  clothing  will 


284  BUDGETARY  CONTROL 

usually  be  much  more  extensive  than  the  advertising  of 
groceries.  Yet  the  sales  of  the  grocery  department  may  be 
larger  than  the  sales  of  the  ladies*  ready-to-wear  department ; 
hence,  according  to  the  system  of  allocation  based  on  sales, 
it  may  be  charged  more  for  advertising.  This  gives  inac- 
curate figures,  and  if  the  departmental  heads  are  paid  a 
bonus  on  profits,  it  leads  to  an  unfair  chargef  against  the 
profits  of  the  head  of  the  grocery  department.  Secondly, 
if  advertising  is  distributed  on  the  basis  of  sales,  each  de- 
partmental head  will  try  to  secure  as  much  advertising  as 
possible,  since  he  will  feel  that  each  of  the  other  departments 
must  pay  part  of  its  cost  which  results  in  his  department's 
paying  only  a  small  part  of  the  total.  He  naturally  con- 
cludes that  he  must  certainly  get  more  benefit  from  the 
advertising  than  it  costs  him ;  therefore  he  will  request  and 
urge  it.  He  will  be  the  more  apt  to  do  this  because  he 
knows  every  other  department  is  seeking  advertising,  for 
which  his  department  must  pay  its  proportionate  part. 

To  be  more  concrete,  the  head  of  Department  A  may  be 
contemplating  a  certain  amount  of  advertising  of  the  arti- 
cles sold  by  his  department,  which  will  cost  $500.  If  the 
entire  $500  were  to  be  charged  against  his  department,  he 
might  decide  immediately  not  to  request  its  expenditure. 
If,  however,  there  are  ten  departments  and  he  knows  that 
on  the  basis  of  sales  only  $60  of  the  cost  of  the  advertising 
will  be  charged  against  his  department,  he  will  feel  that  it 
must  certainly  be  worth  more  than  that  to  him ;  so  he  will 
urge  that  it  be  done.  The  tendency,  therefore,  will  be  for 
the  ratio  of  advertising  to  sales  to  increase  constantly.  Of 
course,  a  capable  advertising  manager  or  merchandise  man- 
ager may  check  this  tendency,  but  it  will  have  to  be  guarded 
against  constantly  with  a  strong  probability  that  the  adver- 
tising will  be  larger  despite  this  vigilance. 

The  brief  consideration  given  to  the  method  of  allocat- 


THE  EXPENSE  BUDGETS 


285 


ing  indirect  expenses  affords  a  basis  for  the  statement  of  the 
general  principle  that  care  should  be  exercised  to  allocate 
them  in  such  a  manner  as  to  attain  two  results : 

1.  Greatest  possible  accuracy. 

2.  The  fixing  of  responsibility  in  such  a  manner  that  those  respon- 

sible for  the  expense  will  desire  to  decrease  and  not  to  increase 
it. 

Selling  and  Manufacturing  Expenses 

The  foregoing  discussion  has  stated  the  general  classifi- 
cations or  groups  into  which  expense  may  be  divided  for 
purposes  of  administrative  control,  and  the  general  principles 
which  should  govern  the  allocation  of  expenses  between 
these  groups.  It  is  now  necessary  to  discuss  briefly  the 
contents  of  each  of  these  groups. 

The  composition  of  selling  expenses  and  manufacturing 
expenses,  and  the  method  of  exercising  control  of  their 
amount,  have  been  discussed  in  connection  with  the  selling 
expense  budget  and  the  manufacturing  expense  budget  re- 
spectively. It  is  not  necessary  to  discuss  these  classes  of 
expense  further.  They  are  included  in  the  classification 
given  at  the  beginning  of  this  chapter  in  order  that  the 
reader  might  have  a  comprehensive  picture  of  the  expense 
problem. 

Financial  Expenses 

The  financial  department,  of  which  the  treasurer  is 
usually  the  executive  head,  incurs  expenses  in  planning  and 
executing  the  financial  program.  In  many  cases  the  credit 
and  collection  departments  are  under  the  control  of  the 
treasurer,  in  which  case  the  expense  of  maintaining  these 
departments  will  be  treated  as  a  financial  expense.  Finan- 
cial expenses  can  usually  be  grouped  under  two  major 
classes:  (i)  office  expense,  and  (2)  credit  and  collection  ex- 


286 


BUDGETARY  CONTROL 


pense.  The  first  will  include  the  salaries  of  the  treasurer  and 
his  assistants,  including  the  cashier,  and  the  cost  of  main- 
taining his  office.  The  latter  will  include  the  cost  of  the 
services  and  supplies  of  the  credit  and  collection  department. 

There  has  been  a  tendency  in  the  past  to  place  the  cost 
of  maintaining  the  financial  department  under  the  general 
heading  of  "administrative"  expense.  This  tendency  is 
probably  due  to  the  fact  that  the  president  in  many  small 
companies  acts  as  treasurer.  Even  when  a  treasurer  is 
appointed,  he  is  often  regarded  as  assistant  to  the  president. 
It  seems  that,  regardless  of  whether  there  is  a  separately 
organized  financial  department,  the  financial  function  is  of 
sufficient  importance  to  merit  the  showing  of  its  costs  as  a 
separate  expense.  This  is  particularly  important  from  the 
viewpoint  of  budgetary  control  where  the  aim  is  to  have  a 
budget  prepared  for  each  functional  department. 

Auxiliary  Expenses 

The  expenses  which  will  be  included  in  this  group  will 
depend  on  the  organization  of  each  particular  business.  In 
a  business  organized  in  accordance  with  the  chart  in  Figure 
25,  the  expenses  incurred  in  maintaining  the  accounting, 
personnel,  office  manager's,  and  purchasing  departments  will 
be  included  in  this  group.  In  a  business  organized  in  accord- 
ance with  Figure  26,  this  group  of  expenses  would  not 
appear,  since  there  are  no  auxiliary  departments.  Instead, 
there  will  appear  the  two  major  groups,  controller's  expense 
and  personnel  expense. 

Where  the  auxiliary  departments  exist,  the  expenses 
charged  to  each  department  will  include  the  cost  of  the  serv- 
ices and  supplies  used  by  the  department.  Sometimes  the 
expense  of  maintaining  these  departments  is  allocated  to  the 
major  departments  of  sales,  production,  and  finance.  From 
the  viewpoint  of  budgetary  and  administrative  control  it  is 


THE  EXPENSE  BUDGETS 


287 


desirable,  if  these  departments  exist  as  separate  units  of 
organization,  that  the  expense  of  each  be  sho\\'n  as  a  separate 
group,  in  order  that  the  responsibility  for  this  expense  may 
be  placed  on  the  executive  head  of  the  department. 

Executive  Expenses 

The  "executive"  expenses  should  include  those  which 
are  incurred  by  the  executives  of  the  business  who  do  not 
devote  their  services  to  any  particular  department,  but  ren- 
der service  to  all  the  departments  in  the  way  of  direction  and 
supervision.  This  will  include  the  salaries  of  the  president 
and  his  staff  assistants  and  the  cost  of  maintaining  their 
offices.  Where  a  general  office  is  maintained  which  is  sepa- 
rate and  distinct  from  the  functional  departments,  these 
expenses  are  frequently  termed  "general  office"  expenses. 

Unless  care  is  taken  to  exercise  control  over  such  expense, 
there  is  a  tendency  for  it  to  increase  unduly.  One  reason 
for  this  tendency  is  that  the  president  of  the  company  is 
usually  vested  with  the  control  of  the  expenditures  incurred 
in  the  general  ofhce  and  it  is  somewhat  difficult  for  him  to 
act  as  criterion  of  his  own  expense.  It  is  desirable  that  the 
amount  of  this  expense  be  presented  to  the  board  of  direc- 
tors in  such  form  that  they  can  easily  judge  of  its  advisa- 
bility. The  board  of  directors  is  the  immediate  superior 
of  the  president  and  therefore  is  the  proper  party  to  pass 
on  his  expenses. 

The  need  for  presenting  these  expenses  to  the  board  of 
directors  for  careful  inspection  is  another  argument  against 
allocating  them  to  the  various  operating  departments,  since 
this  tends  to  obscure  their  amount  and  to  prevent  a  careful 
control  of  them.  The  treatment  of  these  expenses  as  a 
separate  and  distinct  classification  also  facilitates  their 
budgeting  in  the  same  manner  as  the  other  expenses  of  the 
business. 


288 


BUDGETARY  CONTROL 


Corporate  Expenses 

"Corporate"  expenses,  as  that  term  is  used  in  this  dis- 
cussion, include  those  which  must  be  incurred  not  because 
of  any  functions  which  the  corporation  exercises,  but  be- 
cause of  its  existence  as  a  corporate  organization  and  its  rela- 
tion as  such  an  organization  to  governmental  bodies  and 
parties  outside  the  corporate  organization.  These  expenses 
comprise  corporation  fees  paid  to  the  state  government, 
capital  stock  taxes,  directors*  salaries  and  fees,  expenses 
connected  with  the  maintenance  of  stock  registers  and  divi- 
dend records,  and  fees  paid  for  professional  counsel  in  con- 
nection with  appraisals,  business  reports  and  audits  required 
by  creditors.  The  laws  of  most  states  impose  on  corpora- 
tions obligations  in  the  way  of  making  reports,  the  main- 
tenance of  records,  and  the  payment  of  fees.  In  the  prepa- 
ration of  some  of  these  reports,  such  as  income  tax  returns, 
and  also  in  the  preparation  of  reports  to  creditors,  it  may  be 
necessary  to  obtain  professional  counsel  from  attorneys, 
accountants,  and  industrial  engineers.  These  costs  are 
obtained  for  the  benefit  of  the  business  as  a  whole  and  should 
be  shown  as  a  special  group. 

In  many  businesses  a  general  group  of  expenses  known 
as  "administrative"  expenses,  is  maintained,  and  in  this 
group  are  placed  what  in  this  discussion  are  classed  as 
(i)  financial  expenses,  (2)  auxiliary  expenses,  (3)  executive 
expenses,  and  (4)  corporate  expenses.  In  such  cases  the 
items  here  termed  "corporate"  expenses  are  usually  shown 
under  the  heading  of  "general  administrative  expense." 
This  method  does  not  provide  for  an  effective  control  of 
expense  on  the  basis  of  responsibility,  which  we  have  pre- 
viously seen  is  necessary  for  both  administrative  and 
budgetary  purposes.  The  terminology  suggested  in  the 
foregoing  discussion  may  not  be  the  best  possible,  but 
the  general  procedure  outlined  is  one  which  will  provide 


THE  EXPENSE  BUDGETS 


289 


a  proper  basis  for  effective  administration  of  the  expense 
problem. 

Relation  of  Stores  Budget  and  Pay-Roll  Budget  on  the  Expense 
Budgets 

In  previous  chapters  the  stores  and  pay-roll  budgets 
have  been  discussed.  When  these  budgets  are  prepared  it 
is  possible  to  eliminate  the  departmental  expense  budgets, 
with  the  exception  of  the  manufacturing  expense  budget 
and  the  possible  exception  of  the  general  ofhce  expense 
budget  and  the  selling  and  advertising  expense  budget. 
The  supplies  used  by  each  department  will  be  included 
in  the  stores  budget,  and  the  salaries  of  the  employees  will 
be  included  in  the  pay-roll  budget. 

Both  the  advantages  and  disadvantages  of  this  proce- 
dure have  been  discussed  in  previous  chapters  and  need  not 
be  repeated  here. 

Budgetary  Control  of  Expenses 

To  provide  an  effective  control  of  the  expenses  of  the 
various  departments  as  well  as  to  provide  the  necessary  data 
for  the  financial  budget,  it  is  necessary  to  adopt  a  procedure 
which  contains  the  essentials  of  the  following: 

1.  Before  the  beginning  of  each  budget  period,  an  estimate  is  pre- 

pared by  the  executive  head  of  each  department  or  unit,  show- 
ing the  anticipated  expenses  of  this  department  or  unit  for  the 
next  budget  period.  It  is  sent  to  the  executive  in  charge  of 
the  budgetary  procedure. 

2.  All  these  estimates  are  used  by  the  executive  in  charge  of  the 

budgetary  procedure,  probably  with  the  assistance  of  the 
treasurer,  in  preparing  a  financial  budget  and  an  estimated 
statement  of  profit  and  loss. 

3.  The  estimates  are  submitted  by  the  executive  in  charge  of  the 

budgetary  procedure  to  the  budget  committee  or  to  the  board 
of  directors,  or  to  both,  and  after  they  are  revised  by  the  budget 

19 


290 


BUDGETARY  CONTROL 


committee  or  board  of  directors  where  deemed  necessary,  an 
appropriation  is  made  to  meet  the  expenses  called  for  by  each 
estimate. 

4.  The  amount  of  each  appropriation  as  determined  by  the  budget 

committee  or  by  the  board  of  directors,  is  communicated  to  the 
executive  responsible  for  the  original  estimate. 

5.  A  monthly  report  is  made  to  the  budget  committee  or  the  board 

of  directors  through  the  executive  in  charge  of  the  budgetary 
procedure,  showing  the  status  of  each  appropriation. 

6.  The  original  ajipropriation  must  not  be  exceeded  by  any  depart- 

ment without  the  permission  of  the  budget  committee  or  the 
board  of  directors. 

Responsibility  for  the  Preparation  of  Expense  Estimates 

To  insure  the  effecti\^e  operation  of  the  budgetary  pro- 
gram, it  is  necessary  that  definite  responsibihty  for  the 
preparation  and  enforcement  of  the  expense  budgets  be  fixed. 
The  sales  manager  and  the  production  manager  will  be  re- 
sponsible for  the  preparation  of  the  estimate  of  selling  and 
advertising  expense  and  the  estimate  of  manufacturing 
expense,  respectively.  Their  responsibility  in  this  connec- 
tion has  been  explained  in  previous  chapters. 

The  treasurer  will  be  responsible  for  the  preparation  of 
rhe  estimate  of  expenses  for  the  financial  department.  He 
jvill  require  the  preparation  of  estimates  by  the  head  of 
the  credit  and  collection  department  and  by  the  cashier, 
which  he  will  use  in  preparing  the  estimate  for  the  whole 
department. 

The  head  of  each  of  the  auxiliary  departments,  such  as 
the  accounting,  personnel,  purchasing,  and  office  manager's 
departments,  will  be  responsible  for  the  estimate  of  his  de- 
partment. He  may  employ  assistants  in  its  preparation 
at  his  discretion,  but  the  responsibility  for  its  preparation 
will  rest  upon  him. 

The  president  is  responsible  for  the  preparation  of  the 
estimate  of  executive  expenses.    This  duty  he  probably 


THE  EXPENSE  BUDGETS 


291 


will  delegate  to  his  staff  assistant,  and  this  assistant  may 
employ  the  aid  of  other  officers  in  the  office  of  the  president. 

The  estimate  of  corporate  expenses  will  be  prepared  by 
the  official  designated  by  the  president.  This  estimate  may 
be  prepared  by  the  secretary  of  the  corporation,  since  he  is 
conversant  with  the  relations  which  give  rise  to  these  ex- 
penses. In  some  cases  this  estimate  is  prepared  by  the 
treasurer;  but  if  this  practice  is  followed,  care  must  be  exer- 
cised to  keep  the  estimate  entirely  separate  and  distinct 
from  the  estimate  of  expenses  of  the  financial  department 
as  prepared  by  him. 

Form  of  Estimate 

The  work  of  the  executives  who  are  responsible  for  the 
consideration  of  the  departmental  estimates  is  greatly  fa- 
cilitated if  these  estimates  are  presented  in  a  form  which 
shows  comparisons  between  the  estimates  and  past  expenses. 
Usually  it  is  desirable  that  the  form  provide  at  least  the  in- 
formation called  for  by  the  columnar  headings  shown  by 
Figure  27. 

By  a  consideration  of  the  estimates  when  submitted  in 
this  form,  the  executives  can  see  whether  an  increase  of 
expenditures  is  called  for,  and  if  so,  they  can  investi- 
gate to  see  if  this  increase  is  justified.  The  estimates  as 
submitted  by  the  various  departments  will  show  the  salaries 
to  be  paid  to  the  employees  of  these  departments  and  the 
amount  of  supplies  to  be  consumed  during  the  budget  period. 
The  supplies  used  by  all  the  departments  of  the  business  are 
usually  purchased  by  a  central  purchasing  department. 
The  purchasing  agent  buys  these  in  the  quantities  which  he 
thinks  are  most  economical,  and  consequently  there  may  be 
at  any  time  a  considerable  inventory  of  supplies  on  hand. 
The  supplies  consumed  during  any  period,  therefore,  will 
not  correspond  with  the  supplies  purchased  in  that  period. 


292 


BUDGETARY  CONTROL 


After  the  departmental  estimates  are  made,  it  is  neces- 
sary that  these  be  sent  to  the  purchasing  agent,  who,  on  the 
basis  of  the  estimated  consumption  by  the  various  depart- 
ments, will  estimate  the  purchases  which  must  be  made, 
taking  into  consideration  the  terms  on  which  these  will  be 


EXPENSE  BUDGET 

ITEM 

Expenses 
for  Past 
Budget 
Period 

Estimated 
Expenses 
for  Current 
Period 

Per  Cent 
ot 

Increase 
or 

Decrease 

Average 
Expense 
for  Past 

Four 
Periods 

DISTRIBUTION 

First 
Month 

Second 
Month 

Third 
Month 

Etc. 

1 

Figure  27.    Expense  Budget 


secured,  and  will  thus  determine  the  disbursements  for  sup- 
plies for  each  period.  The  estimated  disbursements  are 
necessary  as  a  basis  for  the  preparation  of  the  financial 
budget. 

Monthly  Reports 

To  effect  a  proper  control  of  the  appropriations  made  for 
each  department,  it  is  necessary  to  have  prepared  monthly  a 
report  which  will  show  for  each  department  a  comparison 
between  the  expenditures  of  the  department  to  date  and  the 


THE  EXPENSE  BUDGETS 


293 


appropriation  for  expenses  of  the  department.  Usually 
the  accounting  department  prepares  a  report  showing  the 
actual  expenditures  of  each  department,  and  the  executive 
in  charge  of  the  budgetary  procedure  prepares  the  report 
showing  a  comparison  of  the  expenditures  with  the  appro- 
priation. 

A  difficulty  which  may  arise  from  this  method  is  the 
failure  of  the  accounting  department  to  prepare  the  monthly 


'MONTHLY  REPORT  ON  EXPENSE  APPROPRIATION 

ITEM 

Na.  of 

Appro- 
priation 

Orioinal 
Amount 

Addi- 
tions 

OeduC' 
tions 

Final 
Amount 

Cash 
Dis- 
bursed 

Accounts 
Payable 

Undis- 
bursed 
Balance 

Figure  28.    Monthly  Expense  Appropriation  Report 


report  in  sufficient  time  to  provide  for  a  current  check  upon 
the  monthly  expenditures  of  the  departments.  To  be  of 
service,  the  budget  committee  should  receive  these  com- 
parative reports  shortly  after  the  end  of  the  month.  If 
undue  delay  is  caused  by  depending  on  the  accounting  de- 
partment, it  may  be  necessary  to  have  each  department 


294 


BUDGETARY  CONTROL 


keep  a  special  record  of  its  expenditures  and  report  these  at 
the  end  of  the  month  to  the  executive  in  charge  of  the  budg- 
etary procedure. 

It  is  desirable  that  the  monthly  report  on  departmental 
expenses  contain  at  least  the  inforniation  shown  in  Figure  28. 

Review  and  Summary 

In  the  preceding  pages  the  procedure  necessary  for  the 
preparation  and  execution  of  the  expense  budgets  has  been 
outlined.    In  summary  form  the  procedure  is  as  follows: 

I.  Classification  of  Expenses: 

1.  The  setting  up  of  an  expense  classification  which  corre- 

sponds to  the  classification  of  activities  maintained  by 
the  business  as  shown  by  its  organization  chart. 

2.  The  allocation  of  indirect  expenses  in  such  a  manner  as  to 

indicate  the  responsibility  for  their  incurrence. 

3.  The  establishment  of  subclassifications  under  the  major 

classes,  which  will  enable  the  definite  fixing  of  respon- 
sibility and  a  comprehensive  explanation  of  variations. 

II.  Preparation  of  Budgets: 

1.  The  preparation  of  an  estimate  of  the  expenses  of  each 

department  for  each  budget  period  by  the  executive 
heads  of  the  department. 

2.  The  transmission  of  this  estimate  to  the  budget  committee 

or  the  board  of  directors  for  consideration  and  approval. 

3.  The  making  of  an  appropriation  by  the  budget  committee 

or  the  board  of  directors  to  meet  the  estimate  as  ap- 
proved. 

III.  Control  of  Budgets: 

.  I .  The  preparation  of  a  monthly  report  showing  a  comparison 

between  the  actual  and  estimated  expenditures. 
2.  The  consideration  of  this  report  by  the  budget  committee 
or  the  board  of  directors,  and  the  making  of  such  re- 
visions in  the  original  appropriations  as  may  be  found 
necessary. 


CHAPTER  XIX 


THE  FINANCIAL  BUDGET 

Importance  of  Financial  Planning 

Financial  planning  is  the  essence  of  financial  adminis- 
tration. Without  such  planning  the  success  of  a  business 
is  a  matter  of  accident.  Many  businesses,  especially  small 
ones,  fail  to  plan  ahead  with  reference  to  their  finances  and 
to  this  fact  many  of  the  business  failures  are  due. 

The  reports  of  the  credit  agencies  show  that  the  princi- 
pal cause  for  failure  of  business  firms  is  "lack  of  capital." 
This  lack  of  capital  in  many  cases  could  have  been  prevented 
if  financial  requirements  had  been  estimated  and  plans  made 
in  advance  to  meet  these  requirements.  The  failure  of 
these  firms  was  due  to  the  fact  that  they  waited  until  the 
capital  was  urgently  needed  before  attempting  to  secure  it, 
and  then  they  were  unable  to  get  it.  In  many  cases  its 
urgent  need  arose  from  the  undertaking  of  plans  which  were 
beyond  the  capital  capacity  of  the  businesses  and  which 
would  not  have  been  undertaken  if  the  managers  had  known 
in  advance  the  financial  requirements  to  which  they  would 
give  rise. 

Mr.  Walter  H.  Cottingham,  President  of  the  Sherwin- 
Williams  Company,  writing  in  the  May,  1920  System,  very 
aptly  says: 

The  small  business  does  not  raise  additional  funds  easily.  In 
fact,  no  money  is  raised  "easily" — it  has  to  be  bargained  for.  But 
I  think  a  part  of  the  smaller  man's  difificulty  may  be  traced  to  two 
reasons.  The  first  is  a  lack  of  planning  ahead  and  of  a  consequent 
scheduling  of  money  requirements  for  at  .east  several  years  in  ad- 
vance. This  carelessness  naturally  results  in  a  panicky  getting  of 
money,  only  when  it  is  urgently  needed.    The  second  difficulty  is  in 

295 


BUDGETARY  CONTROL 


analogy :  because  he  has  not  planned  the  owner  has  no  clear,  com- 
prehensive idea  of  just  what  he  can  afford  to  pay  for  money  and  is 
likely  to  insist  upon  too  low  a  price  until  suddenly  he  finds  himself 
"up  against  it."  Then  he  pays  too  high  a  price — if  he  gets  the 
money  at  all. 

The  foregoing  quotation  emphasizes  the  necessity  of 
financial  planning  for  the  small  business,  but  its  need  in  the 
large  business  is  no  less  imperative.  The  principles  dis- 
cussed in  the  following  pages  are  applicable  equally  to  the 
small  and  the  large  business,  although  in  discussing  proce- 
dure a  business  of  sufhcient  size  to  make  expedient  a  func- 
tional division  of  administrative  duties  is  assumed. 

Need  for  Financial  Program 

The  operations  of  all  the  departments  of  a  business 
necessitate  the  use  of  services  and  supplies,  and  the  pur- 
chase of  these  necessitates  the  expenditure  of  funds.  As 
a  result  of  the  operations,  a  service  or  commodity  is  pur- 
chased or  produced,  and  this  commodity  or  service  is  sold. 
From  these  sales,  funds  are  received  either  immediately  or 
at  the  expiration  of  the  period  of  credit  which  is  granted  to 
customers.  The  typical  cycle  may  be  stated  as  follows: 
cash-supplies  and  services-sales-accounts  receivable-cash. 

It  can  be  seen,  therefore,  that  the  operations  of  a  busi- 
ness result  in  the  constant  receipt  and  disbursement  of  funds. 
These  funds  are  in  the  form  of  cash  or  the  equivalent.  Since 
a  business  cannot  continue  to  operate  unless  it  is  able  to 
pay  its  obligations,  it  is  necessary  for  its  operations  to  be 
so  planned  that  its  cash  receipts  will  be  equal  to  its  cash 
disbursements. 

The  ideal  financial  program  would  be  one  which  pro- 
vided for  the  receipt  each  day  of  the  same  amount  of  cash 
which  must  be  disbursed  on  that  day.  It  is  impossible  to 
make  plans  which  are  sufficiently  exact  to  make  possible 


THE  FINANCIAL  BUDGET 


297 


such  a  schedule  of  receipts  and  disbursements,  and  so  it  is 
necessary  to  maintain  a  "cash  balarce"  which  will  insure 
against  a  discrepancy  between  the  cash  receipts  and  the 
cash  disbursements.  The  cash  balance  in  financial  opera- 
tions serves  a  function  similar  to  that  performed  by  the 
merchandise  inventory  in  merchandise  operations. 

The  custody  of  the  cash  receipts,  the  maintenance  of 
the  cash  balance,  and  the  control  of  the  cash  disbursements, 
are  among  the  most  important  functions  of  a  business.  To 
accomplish  these  functions  it  is  necessary  that  the  cash 
requirements  of  a  business  be  determined  in  advance  and 
that  well-formulated  plans  be  made  for  the  satisfaction 
of  these  requirements. 

Long-Time  vs.  Short-Time  Financial  Planning 

In  the  foregoing  discussion  it  has  been  stated  that  a 
business  should  follow  a  far-sighted  policy  and  plan  its 
financial  requirements  several  years  in  advance.  This  is 
undoubtedly  true,  but  it  must  be  obvious  that  such  long- 
time plans  can  be  made  only  in  a  general  way  and  that  they 
will  indicate  the  capital  requirements  only  by  setting  up 
certain  maximum  and  minimum  limits.  For  instance,  a 
manufacturing  firm  may  plan  on  the  expansion  of  its  busi- 
ness over  a  period  of  five  years  and  estimate  the  additional 
plant,  equipment,  and  working  capital  which  it  will  need 
if  the  contemplated  expansion  is  realized.  It  may  secure 
the  authorization  of  sufficient  stocks  or  bonds  to  provide 
the  maximum  amount  of  capital  required  by  its  program, 
and  may  take  such  steps  as  are  possible  to  assure  itself  that 
it  will  be  able  to  issue  these  as  capital  is  needed.  But  if  its 
program  fails  of  realization,  it  will  not  issue  all  the  stocks 
and  bonds  authorized;  or  if  conditions  change  so  that 
their  issuance  is  impossible  or  unprofitable,  it  will  curtail 
its  program. 


298 


BUDGETARY  CONTROL 


On  the  other  hand,  a  business  can  plan  its  immediate 
capital  needs  with  fair  exactness,  and  it  must  estimate 
these  needs  if  it  is  to  assure  itself  that  the  capital  to  meet 
them  will  be  available.  It  may  be  impossible  for  a  business 
to  know  exactly  the  capital  it  will  need  to  finance  the  sales 
which  it  expects  to  obtain  three  years  hence,  but  it  can 
know  quite  definitely  that  if  bank  loans  are  falling  due  dur- 
ing the  next  month  which  are  in  excess  of  its  possible  cash 
receipts  from  customers,  it  must  renew  these  loans  or  obtain 
sufficient  funds  from  other  sources  to  pay  them. 

For  the  present  we  shall  be  interested  in  a  consideration 
of  the  short-time  financial  plans  of  a  business.  But  the 
general  principles  discussed  are  in  the  main  applicable  to 
the  planning  for  long-time  capital  needs. 

Determination  of  Cash  Requirements 

In  the  past  most  business  executives  prepared  their 
estimates  of  financial  requirements  on  the  basis  of  the  re- 
quirements of  previous  years,  taking  into  consideration 
in  a  rough  way  such  factors  as  the  amount  of  business  ex- 
pected for  the  coming  year,  business  conditions,  and  any 
plans  that  may  be  under  way  for  the  extension  of  plant, 
equipment,  etc.  The  method  by  which  these  factors  were 
taken  into  consideration  is  perhaps  not  improperly  to  be 
described  as  "expert  guesswork"  in  the  majority  of  cases. 
The  length  of  time  for  which  any  such  estimate  is  made  will 
depend  on  the  conditions  in  the  particular  line  of  business 
in  question,  though  six  months  and  a  year  have  been  the 
most  usual  periods. 

Such  a  plan  as  this  is  about  all  that  is  possible  where 
a  thoroughgoing  departmental  budget  system  has  not  been 
established,  under  which  each  department  makes  up  a  for- 
mal estimate  of  requirements  and  possible  achievements, 
all  to  be  organized  by  the  chief  executive  in  consultation 


THE  FINANCIAL  BUDGET 


299 


with  the  departmental  heads,  into  a  single  consistent  plan 
for  the  budget  period.  Where  such  a  budget  system  is  in 
existence,  each  departmental  budget  can  be  made  to  show, 
among  other  things,  the  estimated  cash  requirements  and 
estimated  cash  receipts. 

It  is  important  to  bear  in  mind  that  all  budgets,  from 
the  point  of  view  of  executive  control,  fall  roughly  into  two 
classes,  though  the  budget  made  by  one  department  may 
be  composed  of  elements  of  both.  One  of  these  types  is  an 
estimate  of  requirements  for  conducting  the  activities  of 
the  department  along  the  line  proposed,  that  is,  a  requisition 
for  supplies,  materials,  labor,  equipment,  etc.  After  it  is 
approved  it  is  in  the  nature  of  an  allotment,  that  is,  not  to 
be  exceeded  without  permission.  The  various  expense 
budgets  are  good  illustrations  of  this  type.  They  request  a 
certain  amount  of  services  and  supplies  to  carry  on  the  oper- 
ations of  the  departments  for  which  they  are  made. 

The  other  type  is  a  statement  of  the  proposed  accom- 
plishments of  the  department,  a  tentative  promise  to  de- 
liver materials,  services,  etc.,  which,  upon  being  accepted 
as  a  part  of  the  general  plan  of  the  business,  comes  to  be  a 
quota  to  be  attained.  The  sales  budget,  which  states  the 
sales  which  the  sales  department  agrees  to  secure,  and  the 
production  budget,  which  states  the  volume  of  production 
which  the  production  department  promises  to  deliver,  are 
illustrations  of  this  type. 

That  which  from  the  point  of  view  of  one  department  is 
a  quota,  from  the  point  of  \'iew  of  another  may  be  an  allot- 
ment, and  it  is  through  this  dovetailing  of  quota  and  allot- 
ment that  a  budget  system  seeks  to  coordinate  the  activities 
of  all  the  departments  of  an  organization  into  a  single 
unified  policy.  For  instance,  the  volume  of  finished  goods 
stated  on  the  production  budget  is  a  quota  for  the  pro- 
duction department,  but  it  is  an  allotment  to  the  sales 


300 


BUDGETARY  CONTROL 


department,  since  it  states  the  goods  which  the  latter  has 
for  sale.  The  materials  budget  is  an  allotment  to  the 
production  department,  since  it  states  the  materials  it  will 
have  available  for  use,  but  it  is  a  quota  for  the  financial 
department,  since  it  states  the  funds  which  the  latter  must 
procure  to  meet  the  disbursements  called  for  by  the  budget. 

Applying  this  distinction  to  the  financial  budget,  each 
departmental  estimate  of  cash  requirements,  when  ap- 
proved, comes  to  be  an  allotment  of  cash  to  that  depart- 
ment. In  the  same  manner  a  departmental  estimate  of 
cash  receipts  becomes  a  cash  quota  for  that  department. 
In  many  businesses  the  sales  estimate  is  the  only  one  which 
represents  anticipated  cash  receipts. 

Relation  of  Financial  Budget  to  Departmental  Budgets 

Sometimes  the  financial  budget  is  wrongly  regarded  as 
a  departmental  budget.  This  may  probably  arise  from 
the  fact  that  it  is  often  prepared  by  the  treasurer.  From 
the  foregoing  discussion  it  can  be  seen  that  this  view  is 
clearly  erroneous.  The  financial  budget  is  not  a  budget 
of  the  treasurer's  department,  but  a  combination  of  the 
budgets  of  all  the  departments.  The  financial  budget 
must  state  the  funds  which  are  needed  to  finance  all  the 
activities  of  a  business,  and  these  activities  are  stated  in 
the  departmental  budgets. 

Some  business  firms  have  attempted  to  make  a  financial 
budget  without  making  careful  departmental  budgets. 
In  these  cases  the  treasurer  or  controller  prepares  estimates 
of  cash  receipts  and  disbursements  based  on  past  operations 
and  such  contemplated  changes  of  which  he  is  cognizant. 
This  procedure  has  usually  resulted  in  unsatisfactory  re- 
sults for  two  reasons: 

I.  The  financial  budget  cannot  be  made  accurately  without  the 
use  of  the  departmental  estimates,  for  it  is  impossible  for 


THE  FINANXIAL  BUDGET 


301 


the  treasurer  or  controller  to  know  accurately  the  plans  of 
all  the  departments. 
2.  It  is  necessary  to  control  the  activities  of  the  various  depart- 
ments in  order  to  enforce  or  carry  out  the  financial  budget, 
and  this  can  be  done  only  through  the  departmental  budgets. 
It  is  obvious  that  if  the  disbursements  of  any  department  are 
shown  on  the  financial  budget,  a  departmental  budget  must 
be  established  so  that  the  disbursements  of  this  department 
will  not  exceed  the  amount  stated. 

Determination  of  Cash  Receipts 

In  estimating  the  cash  receipts  of  a  business,  it  is  neces- 
sary to  determine  all  sources  from  which  cash  may  be  ob- 
tained. The  number  and  nature  of  these  sources  will  de- 
pend on  the  nature  of  the  operations  of  the  business.  In 
a  mercantile  or  industrial  business  the  principal  source  of 
cash  receipts  is  its  sales.  At  the  beginning  of  any  budget 
period  there  will  be  certain  accounts  receivable  outstanding 
from  which  funds  will  be  received  during  the  next  budget 
period,  and  there  will  be  additional  accounts  receivable  re- 
sulting from  the  sales  during  the  period  from  which  col- 
lection will  be  derived  during  the  period.  In  a  retail  store 
there  will  also  be  receipts  from  cash  sales. 

The  method  to  be  employed  in  estimating  the  receipts 
from  accounts  receivable  and  sales  depends  on  the  number 
of  customers  and  the  terms  on  which  they  are  sold.  In  a 
small  business  or  in  a  business  which  has  few  customers,  it 
is  possible  to  take  each  customer  and  estimate  the  amount 
which  will  be  obtained  from  the  accounts  receivable  which 
he  owes  at  the  beginning  of  the  budget  period,  and  also  the 
amount  of  the  sales  which  will  be  made  to  him  during  the 
budget  period  and  the  collections  which  will  be  made  during 
the  period  from  the  accounts  receivable  arising  from  these 
sales.  In  a  large  business  which  has  many  customers, 
this  method  is  impracticable.    In  such  a  case  the  method 


302 


BUDGETARY  CONTROL 


to  be  followed  will  be  determined  largely  by  the  terms  on 
which  the  sales  are  made. 

In  a  retail  department  store  a  considerable  part  of  the 
sales  are  for  cash.  The  sales  on  account  are  due  at  the 
end  of  the  month  and  presumably  are  paid  during  the  first 
few  days  of  the  following  month.  In  such  a  business  it  is 
necessary  to  estimate  separately  the  cash  sales  and  the 
sales  on  account.  The  records  will  show  the  ratio  of  cash 
sales  and  account  sales  to  total  sales  during  the  past,  and 
these  ratios  can  be  used  in  estimating  the  amount  of  the 
total  estimated  sales  which  will  be  made  on  each  of  these 
terms.  The  cash  sales  will  result  in  cash  receipts  for  the 
month  in  which  they  are  made,  while  the  sales  on  account 
will  result  in  cash  receipts  during  the  following  month. 
In  the  case  of  the  account  sales,  allowance  must  be  made 
for  the  bad  debts  and  also  for  those  accounts  which  will 
not  prove  bad  but  will  not  be  paid  promptly.  The  amount 
of  both  these  accounts  can  be  estimated  on  the  basis  of 
past  experience. 

In  some  businesses  sales  are  made  on  terms  which  re- 
sult in  the  payment  for  all  the  sales  of  each  month  on  the 
same  day.  For  instance,  a  customer  is  sent  a  statement 
at  the  end  of  each  month  for  his  purchases  during  the  month 
and  he  pays  on  the  fifteenth  of  the  following  month.  In 
such  cases  it  is  not  difficult  to  estimate  when  the  cash  re- 
ceipts from  the  sales  will  be  obtained. 

If  a  business  sells  on  terms  of  i/io,  n/30;  1/20,  n/30, 
etc.,  which  result  in  the  receipt  of  cash  from  accounts  re- 
ceivable throughout  the  month,  it  is  necessary  to  resort  to 
ratios  to  estimate  the  cash  receipts  from  estimated  sales. 
A  study  of  past  records  will  show  in  many  businesses  that 
there  is  a  fairly  uniform  ratio  between  sales  and  collections. 
This  ratio  may  vary  during  different  months  or  seasons  of 
the  year,  and  it  may  vary  during  different  years  owing  to 


THE  FINANCIAL  BUDGET 


303 


trade  and  market  conditions.  But  by  careful  study  it  is 
often  possible  to  obtain  a  ratio  which  is  approximately 
correct. 

After  the  ratio  of  collections  to  sales  for  past  periods  is 
obtained,  it  is  applied  to  the  estimated  sales  for  each 
month  of  the  next  period  to  determine  the  estimated  cash 
receipts  for  each  month.  The  inaccuracies  which  may  arise 
from  this  method  are  apparent.  It,  of  course,  will  be  under- 
stood that  it  is  never  possible  to  obtain  exact  estimates  of 
cash  receipts  or  disbursements.  We  carry  a  cash  balance 
primarily  to  provide  for  these  inaccuracies. 

Because  of  the  wide  and  unforeseen  fluctuations  in  the 
volume  of  sales  during  the  past  eighteen  months,  some 
firms  have  found  it  impossible  to  use  the  ratio  of  sales  to 
collections  as  a  basis  of  estimating  their  cash  receipts. 
Various  other  methods  have  been  devised.  One  business 
has  found  that  they  receive  no  cash  receipts  during  the 
month  from  sales  made  after  the  twentieth  of  the  month. 
Accordingly  they  add  the  estimated  sales  for  the  first 
twenty  days  of  the  month  to  the  accounts  receivable  out- 
standing at  the  beginning  of  the  month,  and  use  the  sum 
as  the  basis  of  their  estimate  of  cash  receipts  for  the  month. 
Experience  has  shown  that  they  can  expect  to  collect  a 
fairly  uniform  percentage  of  this  amount  during  the  month. 

Estimate  of  Cash  Receipts  Based  on  Lag  of  Collections  on  Sales 

Another  method  of  handling  this  problem  is  suggested 
by  Mr.  Morris  A.  Copeland  in  the  December,  1920  issue 
of  the  Journal  of  Political  Economy.  At  the  author's  re- 
quest, Mr.  Copeland  has  submitted  the  following  statement 
in  explanation  of  this  method : 

One  method  of  handling  the  problem  is  to  calculate  the  average 
turnover  or  collection  period,  and  use  this  directly  as  a  lag  on  sales. 
The  average  turnover  period  of  accounts  receivable  in  fractions  of  a 


304 


BUDGETARY  CONTROL 


year  is  the  average  of  accounts  receivable  at  the  end  of  each  month 
divided  by  the  amount  of  the  collections  for  the  year.  In  case  this 
should  proN'e  to  be  one-twelfth,  the  sales  estimate  for  March 
would  be  the  collections  estimate  for  April,  etc.  But  if  it  were 
twenty  days,  instead  of  a  month,  the  collections  for  May  would  be 


$200,000 


'  150,000 


100.000 


50,000 


Figure  29.    Graph  Showing  Accumulated 
Sales  and  Collections 


approximately  equal  to  the  sales  from  April  il  to  May  11,  a  figure 
which  cannot  be  obtained  conveniently  from  the  sales  estimate  if  it 
states  the  sales  by  calendar  months. 

Partly  on  this  account  and  partly  because  the  collections  period 
may  vary  from  season  to  season,  and  is  sure  to  vary  according  to 
business  conditions,  the  whole  thing  may  be  shown  more  easily 
graphically.    It  is  evident  that  if  the  collections  period  varies,  the 


THE  FINANCIAL  BUDGET 


collections  for  one  month  will  not  correspond  to  the  sales  during  an 
interval  of  equal  length.  For  a  good  mathematical  reason  which 
we  need  not  go  into  here,  it  is  best  to  show  the  sales  and  collection 
in  cumulative  form,  i.e.,  to  show  the  total  sales  from  January  I  to 
each  succeeding  date. 

Figure  29  illustrates  the  graphical  method.  The  dates  are 
shown  in  the  horizontal  scale  (Sundays  and  holidays  should  be 
omitted) ;  the  amounts  are  shown  on  the  vertical.  This  diagram  is 
based  on  the  following  data: 


Estimated 

Month  Sales  Estimate  Collection 

Period 

December   $50,000         20  days 

January   35>ooo         30  " 

February   25,000         28  " 

March   20,000         35  " 

April   25,000         30  " 

May   30,000         25  " 

June   30,000         20  " 


$215,000 

The  estimated  collection  period  is  measured  from  the  first  of 
each  month,  and  is  the  horizontal  distance  from  the  sales  graph  at 
that  time  to  the  collections  graph.  The  collections  graph isobtained 
by  connecting  the  right-hand  ends  of  these  horizontal  lines.  From 
it  we  can  read  off  the  collections  estimate  for  any  month,  as  January 
$37,500  and  May  $32,500. 

Cash  Receipts  from  Miscellaneous  Sources 

After  the  estimate  of  collections  from  sales  is  made,  it 
is  necessary  to  determine  whether  cash  may  be  received 
from  any  other  source.  In  many  cases  interest  is  received 
on  bank  balances.  If  notes  are  taken  from  customers, 
these  will  often  bear  interest.  If  stock  or  bonds  of  other 
companies  are  o^vned  by  the  company,  the  probable  income 
from  dividends  or  interest  must  be  considered.  If  a  com- 
pany maintains  a  restaurant  for  employees,  cash  receipts 
will  result  therefrom.  If  a  company  o^vns  houses  which  it 
20 


3o6 


BUDGETARY  CONTROL 


rents  to  employees,  the  cash  receipts  to  be  received  from 
these  must  be  included.  In  some  businesses  there  may  be 
other  sources  of  income.  In  any  case,  all  these  sources 
must  be  carefully  considered  and  recorded  in  the  estimate 
of  cash  receipts.  It  is  not  difficult  to  estimate  the  cash 
receipts  from  any  of  these  sources. 

It  may  be  well  to  add  a  word  of  caution  to  the  effect 
that  a  careful  distinction  must  be  made  between  cash 
receipts  and  accrued  income.  For  instance,  interest  on 
bonds  owned  may  accrue  in  one  period  but  not  be  paid 
until  a  subsequent  period.  On  the  other  hand,  interest 
may  be  received  during  one  period  which  has  accrued  over 
several  past  periods.  It  will  be  seen,  therefore,  that  the 
amount  of  interest  and  similar  items  recorded  on  the 
financial  budget  during  any  period  will  in  all  probability 
not  agree  with  the  amount  of  these  same  items  as  entered 
in  the  financial  records. 

Estimating  the  Cash  Receipts  for  Dififerent  Types  of  Business 

In  a  professional  firm  the  principal  source  of  cash  re- 
ceipts is  from  the  sale  of  services  to  clients,  and  an  estimate 
of  the  cash  receipts  from  this  source  can  be  made  in  a 
manner  similar  to  that  in  which  the  estimate  of  receipts 
from  the  sale  of  commodities  is  determined  in  a  mercantile 
firm.  In  this  connection  it  must  be  remembered  that  an 
engagement  may  not  be  completed  until  a  considerable 
time  after  it  is  sold,  and  if  the  engagement  is  not  unduly 
long  the  client  may  not  be  invoiced  until  it  is  completed. 
It  may  also  be  worth  mentioning  that  clients  are  often 
dilatory  in  paying  for  professional  services.  Usually  there 
is  no  discount  offered  for  prompt  payment,  nor  even  are 
specific  terms  stated  on  the  invoices  of  professional  firms. 
Consequently  a  firm  is  apt  to  postpone  payment  of  the 
invoice  for  professional  services  and  pay  an  invoice  for 


THE  FINANCIAL  BUDGET 


307 


merchandise  on  which  a  discount  is  offered.  These  factors 
must  be  considered  in  preparing  the  estimate  of  cash 
receipts  of  a  professional  firm. 

In  a  financial  institution,  such  as  a  bank,  the  principal 
sources  of  cash  receipts  are  entirely  different  from  those  of 
a  mercantile  or  industrial  firm,  but  the  method  of  deter- 
mining the  amount  of  these  in  the  two  cases  is  not  greatly 
dissimilar.  A  bank  derives  its  chief  income  from  interest 
on  loans,  and  the  amount  of  the  receipts  from  this  source  is 
not  difficult  to  determine.  The  receipts  from  exchange, 
investments,  etc.,  are  not  difficult  to  estimate.  Care  must 
be  exercised  here  as  in  other  businesses  to  distinguish  care- 
fully between  accrued  income  and  cash  receipts. 

In  other  types  of  businesses  there  are  still  other  sources 
of  cash  receipts,  but  if  the  general  principles  developed  in 
the  foregoing  discussion  are  kept  in  mind,  it  should  not  be 
difficult  to  develop  a  procedure  for  making  an  estimate  of 
cash  receipts  for  any  type  of  business. 

Form  of  the  Estimate  of  Cash  Receipts 

In  making  up  the  estimate  of  cash  receipts,  a  careful 
record  should  be  made  of  the  amount  estimated  to  be  re- 
ceived from  each  source.  A  form  should  be  designed  to 
show  the  estimated  receipts  for  each  month  of  the  budget 
period  as  well  as  the  total  for  the  period.  This  enables  the 
budget  committee  to  judge  better  the  financial  program 
which  is  proposed,  and  enables  the  treasurer  to  see  the  cash 
available  each  month,  so  that  he  can  plan  his  cash  dis- 
bursements and  loans.  It  also  makes  possible  a  check  on 
the  financial  program  at  the  end  of  each  month,  since 
the  estimated  receipts  can  be  compared  with  the  actual 
receipts.  These  comparisons  are  valuable  both  in  con- 
trolling the  present  estimates  and  in  the  preparation  of 
future  ones. 


3o8 


BUDGETARY  CONTROL 


A  simple  form  of  the  estimate  of  cash  receipts  is  shown 
in  Figure  30.  This  form  assumes  a  budget  period  of  three 
months  in  length.  If  a  longer  period  is  used  additional 
cohmms  can  be  added. 


ESTIMATED  CASH 

RECEIPTS 

For  Quarter  Ending  March  31,  192 

SOURCE 

JANUARY 

FEBRUARY 

MARCH 

TOTAL 

Accounts  Receivable: 
Customers-Class  A 
Schedule  No.  1 

Customers-Class  8 
Schedule  No.  2 

Customers-Class  G 
Schedule  No.  3 

Notes  Receivable: 
Not  Discounted 
Schedule  No.  4 

Sales: 

Customers-Class  A 
Schedule  No.  5 

Customers-Class  B 
Schedule  No.  6 

Customers-Class  C 
Schedule  No.  7 

Miscellaneous: 

Income  from  investments 
Interest  on  Banl<  Balances 

Total 

Figure  30.    Estimate  of  Cash  Receipts 


Determination  of  Cash  Disbursements 

It  is  necessary  that  an  estimate  of  cash  disbursements 
be  prepared  to  be  used  in  connection  with  the  estimate  of 
cash  receipts  in  order  to  complete  the  financial  budget. 
To  do  this  it  is  necessary  to  prepare  an  estimate  of  the 
expenditures  necessary  to  carry  on  the  operations  of  every 
department  of  the  business.  A  discussion  of  the  various 
departmental  estimates  has  been  given  in  previous  chapters, 


THE  FINANCIAL  BUDGET 


309 


and  the  method  of  estimating  the  cash  disbursements  re- 
quired by  each  has  been  explained. 

A  brief  review  of  the  discussion  in  the  previous  chapters 
will  be  given  here  to  show  the  relation  of  these  estimates  to 
the  estimate  of  cash  disbursements. 

Disbursements  for  Purchases  of  Mercantile  Store 

The  principal  disbursements  of  a  mercantile  business  are  ' 
for  merchandise.    The  purchases  budget,  if  prepared  in 
the  form  explained  in  Chapters  XIV  and  XV,  will  show  the 
following  information  for  each  month  of  the  budget  period : 

1.  Inventory  at  beginning  of  month. 

2.  Estimated  deliveries  to  stock  during  month. 

3.  Estimated  orders  to  be  placed  during  month. 

4.  Estimated  inventory  at  end  of  month. 

5.  Estimated  cash  disbursements  for  purchases  made  during  pre- 

vious months. 

6.  Estimated  cash  disbursements  for  purchases  made  during  the 

month. 

Items  (5)  and  (6)  will  be  added  for  each  month  and  entered 
in  the  estimate  for  cash  disbursements. 

It  is  usually  easier  to  estimate  the  disbursements  for 
purchases  than  to  estimate  the  receipts  from  sales.  The 
purchases  are  made  in  large  quantities  and  consequently 
there  are  fewer  creditors  than  there  are  customers.  A  busi- 
ness controls  the  payment  of  its  liabilities  and  knows 
whether  it  will  take  its  discounts  or  wait  until  the  end  of 
the  credit  period.  It  does  not  control  the  receipts  from 
customers  and  can  judge  what  they  will  do  only  by  what 
the  past  indicates.  After  the  purchasing  department  knows 
the  purchases  which  must  be  made  to  meet  sales  demands, 
it  should  not  have  any  particular  difficulty  in  preparing  the 
purchases  budget  so  that  it  will  show  the  infoniiation  stated 
above. 


310 


BUDGETARY  CONTROL 


Disbursements  for   Production  Purposes  by  Manufacturing 
Business 

The  principal  disbursements  of  a  manufacturing  business 
are  for  materials,  labor,  and  manufacturing  expenses. 
The  method  of  estimating  the  amount  of  each  of  these  and 
the  form  in  which  the  estimate  of  each  should  be  prepared, 
has  been  discussed  in  the  chapters  on  the  materials,  labor, 
and  manufacturing  expense  budgets. 

In  estimating  the  disbursements  for  materials,  a  proce- 
dure similar  to  that  followed  in  estimating  the  disburse- 
ments for  the  finished  goods  of  a  mercantile  firm  is  necessary. 
First,  the  materials  which  are  to  be  purchased  must  be 
determined,  and  then  the  date  of  payment  for  these  pur- 
chases must  be  calculated. 

The  disbursements  for  labor  are  ordinarily  made  dur- 
ing the  same  period  in  which  the  labor  is  consumed.  If 
the  estimate  of  disbursements  is  made  on  the  basis  of  cal- 
endar months  this  may  not  be  true,  for  labor  may  be  paid 
on  a  weekly  basis.  In  this  case  there  is  apt  to  be  an  accrued 
pay-roll  at  the  end  of  the  month  which  will  need  to  be  paid 
d\iring  the  following  month.  Some  firms  use  a  four- week 
period  instead  of  a  calendar  month  as  the  basis  for  both 
their  accounting  and  budgetary  records.  This  procedure 
eliminates  the  difficulty  of  accrued  pay-roll  but  may  give 
rise  to  accruals  for  expenses  for  which  invoices  are  rendered 
on  the  basis  of  the  calendar  month. 

A  large  part  of  the  manufacturing  expense  will  con- 
sist of  supplies  which  may  be  purchased  in  one  period 
and  paid  for  during  the  next  period.  Consequently,  the 
disbursements  for  these  must  be  determined  in  a  manner 
similar  to  the  disbursements  for  materials  and  finished 
goods.  Indirect  labor  will  also  be  included  in  the  manu- 
facturing expense  estimate,  and  will  usually  be  paid  for 
during  the  period  in  which  it  is  consumed.    The  re- 


THE  FIXANXIAL  BUDGET  31 1 


ESTIMATED  CASH  DISBURSEMENTS 

For  Quarter  Endina  March  31.  192 

PURPOSE 

January 

February 

Marcti 

Total 

NOTES  Payable 

Accounts  Payable 

Outstanding,  Jan.  1 
Estimated  Cash  Dis- 
bursements for 
Purchases 

Factory  Payroll 

Department  A 
Department  B 
Department  C 

Factory  Expense 

Department  A 
Department  B 
Department  C 

Departmental  Expense 

President's  Office 
Treasurer's  Department 
Auditor's  Department 
Purchasino  Department 
Office  Manaoer's  Department 
Traffic  Department 
Sales  Department 
Production  Department 

Corporate 

Taxes  (.Non-property) 
Attorneys'  Fees 
Directors'  Fees 
Miscellaneous 

TOTAL 

Figure  3 1 .    Simple  Estimate  of  Cash  Disbursements 


312 


BUDGETARY  CONTROL 


marks  with  reference  to  direct  labor  are  equally  applicable 
here. 

In  a  manufacturing  business  there  will  be  disbursements 
for  manufacturing  plant  and  equipment,  and  in  all  busi- 
nesses there  will  be  disbursements  for  furniture  and  office 
equipment.  The  preparation  of  the  estimate  for  plant 
and  equipment  has  been  discussed  in  Chapters  XVI  and 
XVII.  This  estimate  shows  the  plant  and  equipment 
desired  and  the  date  when  needed.  The  purchasing  agent 
will  need  to  use  this  as  a  basis  for  estimating  the  date  of 
payment  for  the  equipment  purchased. 

Disbursements  for  Expenses 

After  the  expenditures  necessary  to  obtain  the  goods 
needed  to  supply  the  sales  demands,  and  the  disbursements 
necessary  to  secure  the  required  amount  of  plant  and  equip- 
ment, are  determined,  it  is  necessary  to  estimate  the  dis- 
bursements which  must  be  incurred  in  operating  the  busi- 
ness so  as  to  secure  the  sales  and  deliver  the  goods  to  the 
customers.  This  requires  the  preparation  of  an  estimate 
of  selling  expenses  by  the  sales  department,  an  estimate  of 
executive  expenses  by  the  general  office,  an  estimate  of 
corporate  expenses  by  the  secretary  or  some  other  official 
designated  by  the  president,  and  an  estimate  of  auxiliary 
expenses  by  each  of  the  service  departments,  such  as  the 
personnel  department,  purchasing  department,  etc. 

The  content  and  form  of  the  various  expense  estimates 
have  been  discussed  in  Chapter  XVIII. 

Form  of  the  Estimate  of  Cash  Disbursements 

In  making  up  the  estimate  of  cash  disbursements,  a 
careful  record  should  be  made  of  the  estimated  amount  to 
be  disbursed  for  each  purpose.  A  form  should  be  designed 
to  show  the  estimated  disbursements  for  each  month  of  the 


THE  FINANCIAL  BUDGET 


313 


MONTHLY  REPORT  ON  ESTIMATED  CASH  DISBURSEMENTS 

Month  of  December,  1921 

Estimated  Disbursements  at  the  General 

Office: 

General  Office  Pay-Roll 

$TO  "^T  T 

•45 

General  Office  Building  Rental 

3.541 

67 

Interest  Payable  on  Notes 

6,700 

.00 

Interest  Payable  on  Bonds 

50,000 

00 

Dividends 

25  000 

.00 

South  X  Real  Estate  Tax  

48I800 

00 

A  State  Tax 

00 

Equipment  (General  Office)  

210 

00 

Other  General  Office  Purchases,  etc  

6,425 

00 

Advertising  

6,411 

00 

Eastern  Division  and  X  Works — Pay-Roll .... 

133.166 

46 

Eastern  Division  and  X  Works — Purchases 

(except  Pipe)  

94,000 

00 

X  Branch  Pay-Roll  

10,500 

00 

Branch  Pay-Rolls  Paid  from  General  Office 

except  X  Branch  

4,998 

34 

X  Branch  Purchases  

14,500 

00 

Consigned  Pipe  Purchases  

68,350 

00 

$486,058.92 

75,000.00 

Estimated  Disbursements  at  Western  Divi- 

sion AND  Y  Works  

310,500.00 

Estimated  Disbursements  of  Branches: 

A  Branch  

$36,500.00 

B  Branch  

30,000 

00 

C  Branch  

65,000.00 

25,000.00 

156,500.00 

Estimated  Disbursements  of  M  Company 

of  Oregon: 

Outside  Purchases  and  Pay-Roll  

$75,000 

00 

To  M  Manufacturing  Company  

20,000 

00 

95,000.00 

Estimated  Disbursements  of   M  Interna- 

tional Company: 

Outside  Purchases  and  Pay-Roll  

S39.000 

00 

80,000.00 

119,000.00 

Total  

$ 

1,242,058  .92 

Figure  32.    More  Elaborate  Estimate  of  Cash  Disbursements 


314 


BUDGETARY  CONTROL 


budget  period  as  well  as  the  total  for  the  period.  This 
enables  the  budget  committee  to  judge  better  the  financial 
program  which  is  proposed  and  enables  the  treasurer  to  see 
the  cash  required  each  month,  so  that  he  can  make  plans 
to  secure  the  necessary  amount.  It  also  makes  possible 
a  check  on  the  financial  program  at  the  end  of  each  month, 
since  the  estimated  disbursements  can  be  compared  with 
the  actual  disbursements.  These  comparisons  are  valuable 
both  in  controlling  the  present  estimates  and  in  the  prep- 
aration of  future  estimates. 

A  simple  form  of  the  estimate  of  cash  receipts  is  shown 
in  Figure  31.  This  form  assumes  a  budget  period  of  three 
months  in  length.  If  a  longer  period  is  used,  additional 
columns  can  be  added. 

Estimating  the  Cash  Disbursements  for  Different  Types  of 
Businesses 

In  different  types  of  businesses  the  method  of  estimating 
the  cash  disbursements  will  vary  somewhat  because  of  the 
different  operations  they  perform,  but  the  same  general 
procedure  will  be  followed  in  preparing  the  estimate  of 
cash  disbursements. 

In  a  professional  firm  the  principal  item  of  disbursements 
will  be  the  salaries  of  the  staff.  The  amount  of  these  will 
be  easy  to  obtain.  In  addition  there  will  be  the  disburse- 
ments necessary  for  maintaining  the  office.  These  also 
can  be  estimated  easily. 

In  a  financial  institution,  such  as  a  bank,  there  will  be 
three  principal  items  of  disbursements:  (i)  the  interest  paid 
on  deposits,  (2)  the  salaries  of  the  employed  staff,  and  (3) 
the  office  expenses.  None  of  these  are  difficult  to  estimate. 
In  estimating  the  cost  of  supplies  used  in  the  various  offices 
the  same  problems  arise  as  in  the  estimating  of  the  disburse- 
ments for  purchases  of  a  mercantile  or  industrial  firm. 


THE  FINANCIAL  BUDGET 


In  other  types  of  businesses  there  are  still  other  purposes 
for  which  disbursements  must  be  made,  but  if  the  general 
principles  developed  in  the  foregoing  discussion  are  kept 
in  mind,  it  should  not  be  difficult  to  develop  a  procedure  for 
making  the  estimate  of  cash  disbursements  for  any  of  these. 

Various  Items  Appearing  on  Estimate  of  Cash  Disbursements 

The  estimate  of  cash  disbursements  shown  in  Figure  31 
is  purposely  made  quite  simple.  In  many  businesses  more 
numerous  items  would  appear  on  this  estimate.  As  an 
indication  of  some  of  the  items  which  may  appear  on  such 
an  estimate.  Figure  32  shows  the  estimate  of  cash  disburse- 
ments of  a  large  manufacturing  firm  for  the  month  of 
December,  1921. 

The  amounts  have  been  changed  since  these  are  im- 
material for  our  purposes.  This  company  has  two  fac- 
tories and  seven  branches.  The  classification  of  items 
shown  on  the  estimate  is  not  the  most  desirable,  but  is  the 
one  found  most  expedient  by  the  company  at  its  present 
stage  of  development  in  financial  control. 


I 


CHAPTER  XX 


THE  FINANCIAL  BUDGET  (Continued) 

Relation  of  Financial  Budget  to  Bank  Loans 

After  the  estimates  of  cash  receipts  and  cash  disburse- 
ments are  completed,  a  statement  can  be  prepared  showing 
the  relation  of  the  estimated  receipts  to  the  estimated  dis- 
bursements. If  the  disbursements  exceed  the  receipts,  the 
excess  will  usually  be  met  by  means  of  bank  loans.  If  the 
receipts  exceed  the  disbursements,  the  excess  will  usually 
be  used  in  the  reduction  of  bank  loans  contracted  during 
previous  periods  when  the  disbursements  exceeded  the 
receipts. 

In  determining  the  amount  of  the  loans  necessary,  or 
vice  versa,  the  cash  balance  at  the  beginning  of  the  period 
and  the  desired  cash  balance  at  the  end  of  the  period  must 
be  taken  into  consideration.  The  amount  of  the  cash 
balance  may  be  determined  by  what  the  firm  has  learned 
by  experience  is  a  necessary  minimum,  or  it  may  be  deter- 
mined by  the  minimum  requirements  of  the  banks.  Banks 
usually  insist  that  the  cash  balance  be  maintained  at  a 
certain  percentage  of  the  loans  obtained  from  them. 
Consequently,  as  the  loans  at  a  bank  increase,  the  cash 
balance  must  increase  accordingly. 

A  simple  form  of  statement  which  will  provide  the  in- 
formation suggested  in  the  preceding  discussion  is  shown  in 
Figure  33. 

In  this  illustration  it  is  assumed  that  the  disbursements 
are  such  that  loans  are  required.  If  the  opposite  situation 
exists,  the  last  item  on  the  summary  will  read  "Loans  to 
be  Liquidated,"  instead  of  "Loans  Required." 

316 


THE  FINANCIAL  BUDGET 


317 


Program  for  Bank  Loans 

On  the  basis  of  the  estimated  cash  receipts  (Figure  30, 
page  308),  the  estimated  cash  disbursements  (Figure  31, 
page  311),  and  the  summary  of  financial  requirements 
(Figure  33),  it  is  possible  to  prepare  a  statement  showing 
the  program  to  be  followed  with  reference  to  bank  loans. 
The  contents  of  such  a  statement  is  indicated  by  Figure  34. 

A  statement  made  in  this  form  is  useful  to  the  president 
and  board  of  directors,  since  it  shows  them  the  effect  of  the 
contemplated  program  on  the  bank  indebtedness.    If  they 


SUMMARY  OF  FINANCIAL  REQUIREMENTS 
For  Quarter  Ending  March  31,  192_ 


January 

February 

March 

Total 

Cash  Balance  at  the 

Beginning  of  Month 
Receipts 

Total 
Disbursements 

Excess  of  Disbursements 
Cash  BaTance  a't'^Ehd  of 
Month 

Loans  Required 

Figure  33.    Summary  of  Financial  Requirements 


approve  the  program  as  suggested,  they  may  authorize  the 
treasurer  to  carry  out  its  provisions.  The  treasurer,  in 
addition  to  this  program,  will  need  a  more  detailed  state- 
ment which  will  show  him  the  exact  dates  on  which  addi- 
tional funds  must  be  obtained,  with  the  consequent  renew- 
ing of  notes,  discounting  of  customers'  notes,  etc. 

Preparation  of  Financial  Budget 

The  various  departmental  estimates  as  sent  to  the  exec- 
utive in  charge  of  the  budgetary  procedure  provide  the 


318 


BUDGETARY  CONTROL 


data  from  which  the  estimates  of  cash  receipts  and  cash 
disbursements  are  prepared.  Some  of  these  estimates 
provide  information  which  can  be  transferred  directly  to 


SUGGESTED  PROGRAM  FOR  BANK  LOANS 
For  Quarter  Ending  March  31,  1922 


Situation  at  Beginning  of  Quarter: 

Notes  Payable   $  500,000 

Notes  Receivable  Discounted   780,000 


Total   $1,280,000 

Monthly  Program: 
January: 

Renew  $45,000  of  $47,500  due 

Reduction  of  Notes  Payable  for  Month   $  2,500 

Notes  Receivable  Discounted  Matured   300,000 


Total  Reduction  of  Indebtedness  to  Bank   $  302,500 

February: 

Renew  $75,000  of  Notes  falling  due 

Notes  Receivable  Discounted  Matured   $  290,000 


Total  Reduction  of  Indebtedness  to  Bank   $  290,000 

March: 

Renew  $60,000  of  Notes  falling  due 

Discount  Notes  of  R.  L.  S.  and  J.  J.  S.  for  $71,000 

Increase  of  Indebtedness   $  71,000 

Notes  Receivable  Discounted  Matured   100,000 


Net  Reduction  for  Month   $  29,000 

Situation  at  End  of  Quarter: 

Notes  Payable   $  531,500 

Notes  Receivable  Discounted   90,000 


Total   $  621,500 


Figure  34.    Financial  Program  for  Bank  Loans 

the  cash  estimates.  For  instance,  the  estimate  of  pur- 
chases, if  prepared  in  the  manner  suggested  in  Chapter  XV, 
will  show  the  estimated  disbursements  for  purchases  for 
each  month.    Other  estimates  show  only  the  volume  of 


THE  FINANCIAL  BUDGET 


the  operations  of  the  department  for  which  they  are  made 
and  an  estimate  must  be  prepared  of  the  effect  of  these 
operations  on  the  cash  balance.  The  sales  budget  is  an 
illustration  of  this  type.  It  states  the  estimated  sales 
for  the  budget  period,  but  there  is  a  lag  between  the  sales 
and  the  collections  therefrom,  which  necessitates  that  an 
estimate  of  collections  must  be  prepared,  based  on  the  sales 
estimate. 

In  some  cases  the  cash  estimates  are  prepared  by  the 
executive  in  charge  of  the  budgetary  procedure,  while  in 
other  cases  they  are  prepared  by  the  treasurer.  Probably 
the  best  plan  is  to  have  these  officials  cooperate  in  their 
preparation.  The  executive  in  charge  of  the  budgetary 
procedure  can  easily  obtain  most  of  the  items  of  disburse- 
ment directly  from  the  departmental  estimates.  The 
treasurer  will  prepare  an  estimate  of  the  disbursements  of 
his  department.  He  also  usually  prepares  the  estimate  of 
collections,  since  he  has  available  the  data  necessary  for 
its  preparation.  In  some  cases  he  makes  the  estimate  of 
disbursements  for  corporate  expenses. 

In  any  case,  after  the  cash  estimates  are  completed 
they  should  be  submitted  to  the  treasurer  for  approval 
before  they  are  transferred  to  the  budget  committee.  The 
budget  committee  will  consider  these  in  connection  with  the 
various  departmental  estimates  and  make  any  revisions 
which  it  thinks  necessary.  After  they  are  approved  by 
the  budget  committee  they  will  be  transferred  by  the 
executive  in  charge  of  budgetary  procedure  to  the  depart- 
ments concerned. 

Control  of  Financial  Budget 

After  the  departmental  estimates  have  been  approved 
by  the  budget  committee,  the  departmental  heads  should 
not  be  permitted  to  exceed  their  estimates  without  the 


320 


BUDGETARY  CONTROL 


permission  of  the  committee.  At  the  end  of  each  month  a 
report  should  be  made  to  the  budget  committee,  showing 
a  comparison  between  the  estimated  expenditures  for  each 
department  for  the  budget  period  and  the  actual  ex- 
penditures to  date.  This  report  enables  the  committee 
to  see  the  tendency  in  each  department  and  makes  it 
possible  for  it  to  take  measures  to  prevent  undesirable 
tendencies. 

In  the  same  manner  a  report  should  be  made  showing  a 
comparison  between  the  estimated  and  the  actual  collec- 
tions for  the  month,  since  collections  are  the  principal 
source  of  cash  receipts.  This  report  will  be  more  useful  if 
it  also  shows  comparisons  between  sales  and  collections. 
The  contents  of  such  a  report  are  indicated  by  Figure  35. 
The  percentages  shown  in  this  report,  if  obtained  for  a 
number  of  periods,  will  be  useful  in  estimating  receipts  from 
collections  for  future  periods. 

It  is  important  to  emphasize  that  if  effective  control  is 
to  be  exercised  over  the  financial  budget,  it  is  necessary  to 
control  carefully  the  disbursements  and  receipts  of  the 
separate  departments,  since,  as  previously  explained,  the 
financial  budget  is  but  a  combination  of  the  departmental 
budgets. 

Monthly  reports  should  be  made  showing  a  comparison 
between  the  estimated  receipts  and  the  actual  receipts  from 
all  sources  and  the  estimated  disbursements  and  the  actual 
disbursements  from  all  sources.  These  reports  will  be 
submitted  to  the  budget  committee  together  with  the  other 
budgetary  reports.  Simple  forms  for  these  monthly  re- 
ports of  receipts  and  disbursements  are  shown  in  Figures 
36  and  37.  If  revisions  in  the  various  departmental 
budgets  are  made  on  the  basis  of  the  monthly  reports  re- 
ceived by  the  budget  committee,  these  revisions  must  be 
given  effect  in  the  cash  budget. 


THE  FINANCIAL  BUDGET 


321 


21 


322 


BUDGETARY  CONTROL 


Length  of  Cash  Period 

Although  the  financial  budget  may  be  made  for  a  quar- 
ter, a  half,  or  a  whole  year,  it  is  necessary  to  make  a  com- 
parison between  the  cash  receipts  and  cash  disbursements 
over  shorter  periods  of  time  than  is  represented  by  the 
budget;  otherwise  there  may  be  times  during  the  period 


MONTHLY  REPORT  ON  CASH  RECEIPTS 

MONTH  OF  10? 

SOURCE 

Amount 
Received 

Estimated 
Receipts 

Per  Cent 
Increase 
or 

Decrease 

Comments 

Figure  36.    Monthly  Cash  Receipts  Report 


when  there  will  not  be  sufficient  cash  on  hand  to  meet  cur- 
rent obligations.  For  instance,  the  cash  receipts  from  ac- 
counts receivable  and  miscellaneous  sources  from  January  i 
to  April  I  may  exceed  the  cash  disbursements  for  the  same 
period,  but  there  may  not  be  sufficient  cash  to  meet  cur- 
rent demands  at  one  or  more  times  during  that  period. 
The  demand  for  cash  is  an  imperative  one  and  care  must  be 
exercised  to  see  that  it  is  forthcoming  at  the  time  needed. 


THE  FINANCIAL  BUDGET 


323 


In  the  preceding  discussion  it  has  been  assumed  that 
such  comparisons  will  be  made  monthly.  The  estimated 
receipts  for  each  month  are  compared  with  the  estimated 
disbursements  for  the  month,  and  the  excess  of  disburse- 
ments which  must  be  financed  determined.  Usually  this 
procedure  is  satisfactory,  but  there  may  be  cases  where  the 


MONTHLY  REPORT  ON  CASH  DISBURSEMENTS 

Month  of  IP? 

PURPOSE 

Amount 
Disbursed 

Estimated 
Disbursement 

Per  Cent 
Increase 

Decrease 

COMMENTS 

Figure  37.    Monthly  Cash  Disbursements  Report 

receipts  and  disbursements  fluctuate  so  violently  that  it  is 
necessary  to  have  a  comparison  on  the  basis  of  ten-  or 
fifteen-day  periods.  In  such  businesses  the  fluctuating 
demand  for  cash  is  usually  satisfied  by  arranging  a  "re- 
serve line"  of  credit  at  banks  so  that  additional  funds  can 
be  obtained  immediately  at  any  time  when  they  are  needed. 


324 


BUDGETARY  CONTROL 


Formulation  of  a  Financial  Program 

In  the  foregoing  discussion  the  procedure  by  which  the 
financial  budget  is  prepared  has  been  explained.  It  should 
be  apparent  that  this  procedure  can  be  effective  only  when 
it  is  exercised  as  a  part  of  a  well-formulated  financial  pro- 
gram. It  is  not  only  necessary  to  know  what  the  financial 
requirements  of  a  business  are,  so  that  plans  to  meet  them 
can  be  made,  but  it  is  also  necessary  to  know  that  these 
requirements  are  what  they  should  he.  In  other  words,  it  is 
desirable  to  know  whether  the  financial  program  called  for 
by  the  financial  budget  is  the  one  which  will  be  the  most 
profitable  to  the  business.  A  consideration  of  what  con- 
stitutes a  proper  financial  program  would  necessitate  a 
discussion  of  the  whole  program  of  financial  management 
which  is  beyond  the  province  of  this  discussion. 

There  are  one  or  two  phases  of  the  financial  program, 
however,  which  are  so  vitally  connected  with  the  deter- 
mination of  cash  requirements  that  it  is  worth  while  to 
mention  them  here. 

Constant  and  Variable  Capital  Requirements 

Bankers  have  given  considerable  attention  to  the  analy- 
sis of  the  assets  and  liabilities  of  business  firms  in  connec- 
tion with  the  granting  of  loans.  From  the  viewpoint  of 
credit  granting,  they  have  found  it  desirable  to  differentiate 
between  fixed  assets  and  current  assets,  and  between  fixed 
liabilities  and  current  liabilities.  This  distinction  is  made 
largely  on  the  basis  of  turnover.  An  asset  with  a  slow 
turnover  is  termed  a  "fixed"  asset,  while  one  with  a  rapid 
turnover  is  termed  a  "current"  asset.  Liabilities  are 
classified  in  the  same  manner.  Since  bankers  have  em- 
phasized this  classification  in  their  relations  with  business 
men,  the  latter  have  come  to  regard  it  as  fundamental. 
Many  bankers  have  insisted  on  the  use  of  the  "nile-of- 


THE  FINANCIAL  BUDGET 


thumb"  financial  standard  of  the  "2  to  I "  ratio,  and  busi- 
ness men  have  come  to  believe  that  so  long  as  they  succeed 
in  keeping  their  current  assets  twice  their  current  liabilities, 
they  are  successful  financial  managers. 

The  classification  of  assets  and  liabilities  as  current  and 
fixed  is  very  useful  in  many  cases,  but  it  sometimes  leads  to 
a  confusion  of  thought.  Because  any  particular  piece  of 
merchandise  will  presently  be  converted  into  cash  again, 
it  is  felt  that  it  is  a  less  permanent  form  of  investment  than 
a  building.  From  the  view^Doint  of  credit  this  is  true,  but 
from  the  viewpoint  of  capital  requirements  it  may  not  be  so. 
If  a  concern  never  allows  its  merchandise  inventory  to  fall 
below  $20,000  that  twenty  thousand  dollars  is  as  truly  a 
permanent  investment  in  the  business  as  is  the  cost  of  the 
longest-lived  of  its  permanent  assets.  The  same  may  be 
true  of  current  liabilities.  Many  concerns  never  pay  off  all 
of  their  short-time  loans  at  once.  A  business  that  always 
owes  at  least  $50,000  on  short-time  loans,  though  it  may 
clear  up  its  account  at  each  bank  once  a  year,  is  obtaining 
that  much  permanent  capital  on  commercial  loans. 

From  the  viewpoint  of  financial  administration,  there  is 
a  distinct  difference  between  permanent  assets  and  assets 
which  involve  a  permanent  investment.  During  any  partic- 
ular period  of  time  a  given  asset  or  liability,  whether  per- 
manent or  current,  whether  an  accrued  or  a  deferred  item, 
may  vary  in  amount.  The  proprietorship  may  also  change. 
Of  course  the  variations  in  different  assets  may  not  all  be 
in  the  same  direction  at  the  same  time,  so  that  some  will 
serve  to  offset  others  and  the  same  is  true  of  liabilities  and 
proprietorship. 

For  the  purposes  of  financial  requirements,  what  is  of 
primary  importance  are  the  changes  in  the  totals.  Usually 
the  total  of  each  of  these  items  fluctuates  constantly. 
These  fluctuations  may  be  due  to  seasonal  operations,  in 


526 


BUDGETARY  CONTROL 


which  case  they  are  confined  between  certain  maximum 
and  minimum  Hmits.  Or  they  may  be  due  to  the  expan- 
sion or  contraction  of  the  operations  of  the  business,  in 
which  case  there  may  be  a  constant  increase  or  decrease  for 
a  certain  period  of  time.  Even  here  a  minimum  or  maxi- 
mum will  sooner  or  later  be  reached.  In  the  case  of  a 
decrease  a  minimum  will  be  reached  below  which  the 
business  cannot  continue  to  operate.  In  the  case  of  an 
increase  or  expansion  of  business,  in  time  a  state  of  diminish- 
ing returns  will  be  reached  beyond  which  it  will  be  unprof- 
itable for  the  business  to  expand  and  consequently  the 
assets  of  the  business  will  cease  to  increase. 

The  minimum  total  of  assets  of  a  business  during  the 
period  under  consideration,  such  as  a  year,  may  be  termed 
the  "constant"  assets  of  that  business,  and  the  amount  in 
excess  of  this  minimum  may  be  termed  the  "variable" 
assets.  In  analogous  fashion,  constant  and  variable  lia- 
bilities and  proprietorship  may  be  defined.  Thus,  if  the 
balance  sheet  of  the  King  Manufacturing  Company  on 
June  I,  1 92 1,  shows: 

Assets   $200,000 

Liabilities   120,000 

Proprietorship   $80,000 


and  the  lowest  value  for  the  total  assets  during  the  year  is 
$160,000,  this  will  be  the  constant  assets  and  also  the  con- 
stant liabilities  and  proprietorship.  The  variable  assets 
will  be  $40,000  on  June  i,  and  this  will  be  also  the  amount 
of  the  variable  liabilities  and  proprietorship.  The  varia- 
tions in  the  proprietorship  total  taken  by  itself  will  not 
ordinarily  be  large.  It  will  usually  increase  gradually 
through  an  accumulation  of  profits  and  then  drop  off  at 
the  time  when  dividends  are  paid.    If  the  profits  are  left 


THE  FINANCIAL  BUDGET 


327 


in  the  business,  there  will  be  a  permanent  increase  in  the 
proprietorship,  and  if  losses  are  incurred  there  may  be  a 
decrease.  Proprietorship  may  be  increased  by  a  sale  of 
stock,  but  this  occurs  rarely  in  the  life  of  any  particular 
business. 

The  assets  of  a  business  at  all  times  are  equal  to  the 
proprietorship  plus  the  liabilities.  Since  the  proprietorship 
in  most  businesses  under  normal  conditions  fluctuates  but 
little,  it  follows  that  the  fluctuations  in  the  assets  usually 
result  in  like  fluctuations  in  the  liabilities.  In  other  words, 
the  variable  assets  tend  to  be  offset  by  the  variable  liabili- 
ties. To  illustrate,  by  the  foregoing  example  of  the  King 
Manufacturing  Company,  it  is  evident  that  if  the  pro- 
prietorship remains  approximately  at  $80,000  throughout 
the  year  and  the  assets  are  reduced  to  $160,000  at  the  time 
of  the  "slack  season"  of  the  year,  then  the  liabilities  at 
that  time  of  the  year  will  be  reduced  to  $80,000. 

The  relation  between  the  variable  assets  and  the  varia- 
ble liabilities  is  significant  in  that  it  points  out  the  relation 
between  the  financial  budget  and  the  financial  condition  of 
a  firm  as  showTi  by  its  balance  sheet.  An  illustration  will 
make  this  clear.  It  may  be  assumed  that  the  assets  of  the 
King  Manufacturing  Company  reach  the  minimum  amount 
of  $160,000  on  January  i,  and  that  they  then  gradually 
increase  until  they  reach  the  maximum  amount  of  $200,000 
on  June  l,  after  which  they  gradually  decrease  until  the 
minimum  is  reached  again  on  January  i.  The  increase  in 
assets  between  January  i  to  June  I  will  probably  be  shown 
in  the  main  by  an  increase  in  accounts  receivable  and  mer- 
chandise inventory.  To  carry  the  increase  in  these  items 
the  firm  will  in  all  probability  increase  its  borrowings  from 
banks,  although  some  part  of  the  increase  in  inventory 
may  be  offset  by  an  increase  in  accounts  due  to  trade 
creditors. 


328 


BUDGETARY  CONTROL 


In  so  far  as  the  increase  in  assets  is  offset  by  an  increase 
in  bank  loans,  the  financial  budget  during  this  period  will 
show  an  excess  of  disbursements  over  receipts,  since  it  is  to 
meet  such  an  excess  that  bank  loans  are  contracted. 

During  the  period  from  June  I  to  January  I ,  the  accounts 
receivable  and  merchandise  inventory  will  be  decreasing 
and  the  bank  loans  will  be  decreasing  likewise.  During  the 
same  period  the  financial  budget  will  show  an  excess  of 
receipts  over  disbursements  and  with  this  excess  the  bank 
loans  are  paid. 

Relation  of  Financial  Budget  to  the  Business  Cycle 

The  variable  assets,  and  consequently  the  variable 
liabilities,  will  increase  during  the  busy  season  of  a  season- 
able business,  and  will  increase  for  all  businesses  during  the 
upward  trend  of  the  business  cycle  when  the  operations  of 
a  business  are  expanding.  They  will  decrease  during  the 
dull  season  and  during  the  downward  trend  of  the  business 
cycle.  In  the  same  manner  the  financial  budget  should 
normally  show  an  increase  of  disbursements  in  proportion 
to  receipts  during  the  busy  season  or  upward  trend  of  the 
business  cycle,  and  it  should  show  the  opposite  condition 
during  the  dull  season  and  the  downward  trend  of  the 
cycle. 

Because  of  the  non-liquid  condition  of  the  variable 
assets,  this  "normal"  condition  may  not  exist  during  the 
downward  trend  of  the  business  cycle.  For  instance,  dur- 
ing the  year  1921  many  firms  were  "hard  pressed  "  for  funds 
because  their  variable  liabilities  became  due,  and  their 
variable  assets  were  not  converted.  In  other  words,  it  was 
impossible  to  reduce  their  assets  to  the  minimum  when  it 
became  desirable  to  reduce  their  liabilities.  This  condition, 
however,  does  not  offset  the  general  principle  that  during 
the  downward  trend  of  the  cycle  the  cash  receipts  from  the 


THE  FINANCIAL  BUDGET 


329 


operations  of  the  business  should  exceed  the  disbursements 
other  than  for  bank  loans  and  that  this  excess  should  be 
used  in  paying  these  loans.  The  condition  during  1921 
merely  indicates  that  because  of  inadequate  planning  ahead 
many  businesses  were  in  such  a  condition  when  the  down- 
ward trend  of  the  cycle  came  that  they  could  not  do  what 
the  conditions  of  the  times  demanded. 

Relation  of  Financial  Budget  to  Estimated  Financial  Statements 

The  primary  purpose  of  the  foregoing  discussion  with 
reference  to  variable  assets  and  liabilities  and  the  financial 
budget  is  to  show  the  close  relationship  between  this  budget 
and  the  financial  condition  of  the  business  as  shown  by  its 
balance  sheet.  The  budget  sets  forth  the  results  of  the 
contemplated  operations  of  the  business  in  terms  of  finan- 
cial requirements.  To  interpret  this  budget  properly  and 
to  judge  properly  of  its  desirability,  the  executives  should 
have  before  them  an  estimated  balance  sheet  showing  the 
anticipated  financial  condition  at  the  end  of  the  period  for 
which  the  budget  is  made. 

But  the  purpose  of  the  operations  of  a  business  is  to 
secure  a  profit.  A  contemplated  program  of  expansion  or 
contraction,  as  shown  by  the  financial  budget  and  estimated 
balance  sheet,  is  desirable  only  if  it  will  produce  profitable 
results.  To  determine  whether  this  result  will  be  achieved, 
it  is  necessary  to  have  an  estimated  statement  of  profit  and 
loss  showing  the  anticipated  results  of  the  contemplated 
program  in  terms  of  profit  and  loss. 

The  financial  budget,  the  estimated  statement  of 
profit  and  loss,  and  the  estimated  balance  sheet,  are  the 
three  statements  which  show  the  goal  towards  which  the 
contemplated  operations  of  the  business,  as  reflected  in  the 
departmental  estimates,  are  leading.  If  these  statements 
are  properly  made  and  properly  correlated,  a  basis  for 


330 


BUDGETARY  CONTROL 


sound  and  efficient  management  is  laid.  The  latter  two 
statements  will  be  discussed  in  the  following  chapters. 

Difficult  Problems  in  Preparing  Financial  Budget 

The  preparation  of  the  financial  budget  is  not  an  easy 
matter.  In  most  businesses,  problems  of  considerable 
magnitude  and  difficulty  are  encountered.  Some  of  these 
are  inherent  in  the  problem  of  financial  control  and  some 
are  the  result  of  circumstances  which  exist  in  particular 
businesses  owing  to  personnel  or  to  the  nature  of  the  opera- 
tions of  the  business.  The  nature  of  these  problems  has 
been  indicated  to  some  extent  in  the  previous  discussion. 
In  order  that  it  may  not  be  thought  that  these  difficulties 
have  been  disregarded  or  minimized,  it  is  desirable  to  sum- 
marize them  here.    They  may  be  stated  as  follows: 

1 .  The  financial  budget  is  a  budget  covering  all  the  activities  of  the 

business;  therefore  it  requires  the  cooperation  of  all  the 
departments  of  the  business.  Without  this  cooperation  it 
is  impossible  to  prepare  an  accurate  budget  or  to  enforce  it 
after  it  is  prepared. 

2.  The  cash  receipts  and  the  cash  disbursements  in  many  cases 

are  separated  from  the  activities  which  produce  the  receipts 
or  cause  the  disbursements  by  a  certain  interval  of  time,  and 
it  is  difficult  to  estimate  accurately  the  length  of  this  interval. 
For  instance,  the  collections  from  sales  are  not  made  until 
some  time  after  the  sales  take  place,  and  the  payments  for 
purchases  are  not  made  until  some  time  after  the  purchases 
are  contracted  for. 

3.  The  planning  of  finances  is  in  most  cases  in  the  hands  of  the 

principal  executive  of  the  company  or  of  the  treasurer  who 
acts  as  his  confidential  assistant.  The  financial  methods 
which  these  executives  employ  are  regarded  as  highly  con- 
fidential. Consequently  there  is  little  or  no  exchange  of 
information  between  companies  with  reference  to  financial 
methods,  and  no  standardized  procedure  has  been  developed. 
In  undertaking,   therefore,   the  introduction  of  scientific 


THE  FINANCIAL  BUDGET 


financial  planning,  each  firm  is  dependent  largely  on  its  own 
experiences  and  resourcefulness. 
4.  The  executives  in  charge  of  the  financial  operations  of  a  business 
are  usually  loath  to  delegate  any  duties  with  reference  to  them 
to  others,  and  hesitate  to  commit  their  plans  to  a  definite  form 
for  fear  that  they  will  be  hampered  in  their  freedom  of  action 
and  that  important  information  may  be  divulged. 

None  of  these  difficulties  is  insurmountable,  and  for- 
tunately the  present  tendency  indicates  a  rapid  removal  of 
the  latter  two  and  the  development  of  scientific  methods 
of  overcoming  the  first  two. 

Summary 

In  the  preceding  pages  an  attempt  has  been  made  to 
outline  the  procedure  necessary  for  the  preparation  and 
control  of  the  financial  budget.  In  summary  form  this 
procedure  may  be  stated  as  follows: 

1 .  Preparation  of  a  Preliminary  Estimate  of  Cash 
Receipts.  This  requires  the  determination  of  the  proba- 
ble receipts  from  all  sources.  The  principal  source  of  cash 
receipts  is  the  collections  from  accounts  receivable,  and 
the  estimate  of  collections  must  be  based  on  the  estimate 
of  sales  which  has  been  prepared  in  the  manner  previously 
explained. 

2.  Preparation  of  a  Preliminary  Estimate  of  Cash 
Disbursements.  This  requires  the  determination  of  prob- 
able disbursements  needed  to  finance  the  operations  of  all 
the  departments  of  the  business.  Consequently  the  esti- 
mate of  disbursements  must  be  based  on  the  various  de- 
partmental estimates  which  h^ave  been  explained  in  previous 
chapters. 

3.  Preparation  of  the  Cash  Budget.  The  prelimi- 
nary estimates  of  cash  receipts  and  disbursements  explained 
in  (i)  and  (2)  are  submitted,  together  with  all  the  other 


332 


BUDGETARY  CONTROL 


estimates,  to  the  budget  committee.  After  the  various 
departmental  estimates  have  been  approved,  the  pre- 
Hminary  estimates  of  cash  receipts  and  disbursements  will 
be  revised,  if  necessary,  to  give  effect  to  any  changes  made 
in  the  departmental  estimates  by  the  budget  committee. 
After  the  revised  cash  estimates  are  approved,  they  con- 
stitute a  cash  budget. 

4.  Preparation  of  the  Financial  Program.  Based 
on  the  preliminary  estimates  of  cash  receipts  and  disburse- 
ments, there  will  be  prepared  a  suggested  financial  program 
which  will  indicate  the  financial  procedure  by  which  the 
requirements  of  the  proposed  financial  program  are  to  be 
met.  This  program  will  be  revised,  if  necessary,  to  corre- 
spond to  the  revised  financial  budget  and  will  then  con- 
stitute the  working  program  of  the  financial  department. 

5.  Preparation  of  an  Estimated  Balance  Sheet 
AND  Estimated  Statement  of  Profit  and  Loss.  These 
financial  statements,  discussed  in  the  chapters  immediately 
following,  are  studied  in  connection  with  the  financial  budg- 
et to  determine  the  effect  of  the  contemplated  financial 
program  on  the  financial  condition  and  income  of  the  busi- 
ness. 


CHAPTER  XXI 


THE  ESTIMATED  BALANCE  SHEET 

The  Need  for  Financial  Statements 

Business  management  can  be  exercised  in  a  rational 
manner  only  when  it  is  based  on  accurate  and  comprehen- 
sive information  with  reference  to  the  operations  of  the  busi- 
ness which  is  to  be  administered.  Not  only  must  informa- 
tion be  available,  but  it  should  be  in  the  form  in  which  it 
will  be  the  most  serviceable  to  the  business  manager.  A 
large  part  of  the  information  used  by  the  business  executive 
is  in  the  form  of  statistical  data,  and  experience  has  shown 
that  these  data  are  most  useful  when  presented  by  means  of 
reports  which  show  them  in  a  summarized  and  classified 
form.  Consequently,  business  men  have  long  been  accus- 
tomed to  using  statistical  reports. 

The  nature  of  these  reports  has  been  determined  largely 
by  necessity.  When  the  executive  has  found  that  he  must 
have  certain  information  to  carry  on  some  activity  which 
it  has  been  necessary  to  perform,  he  has  devised,  or  has  had 
devised,  a  report  which  will  provide  him  with  this  informa- 
tion. The  balance  sheet  and  the  statement  of  profit  and 
loss  are  the  two  reports  with  which  the  executive  is  most 
familiar  and  which  are  most  widely  used.  The  reason  for 
the  extensive  use  of  these  reports  is  not  difficult  to  see  if  the 
development  of  accounting  records  and  reports  is  considered. 

Balance  Sheet 

Every  business  finds  it  necessary  in  the  course  of  its  de- 
velopment to  borrow  funds  from  banks  and  to  purchase 
merchandise  on  account.  In  the  not  distant  past  both 
bank  and  merchandise  creditors  often  granted  credit  on  the 

333 


334 


BUDGETARY  CONTROL 


basis  of  the  general  reputation  of  the  appHcant  and  the  in- 
formation which  they  could  obtain  from  him  in  an  informal 
manner.  During  recent  years,  however,  they  have  found 
it  necessary  to  have  more  exact  information  and,  to  obtain 
this,  have  required  a  formal  report  showing  the  financial 
condition  of  the  business.  Consequently,  the  standard 
form  of  balance  sheet  has  been  developed  for  their  use.  The 
executive,  being  required  to  prepare  this  report  for  his 
creditors,  gradually  learned  to  make  some  use  of  it  himself. 

Statement  of  Profit  and  Loss 

For  many  years  creditors  satisfied  themselves  with  the 
information  obtained  from  the  balance  sheet,  but  recently 
they  have  found  it  expedient  to  ask  for  additional  informa- 
tion which  will  show  the  nature  of  the  operations  of  the  busi- 
ness and  the  result  of  these  operations.  They  have  found 
it  desirable  to  have  this  information  because  they  realize 
that,  though  the  balance  sheet  shows  the  financial  condition 
of  the  business  at  the  time  credit  is  requested,  w^hat  the  cred- 
itor is  primarily  interested  in  is  its  financial  condition  at  the 
end  of  the  period  of  credit.  For  instance,  if  a  bank  grants  a 
loan  for  three  months,  it  desires  to  know  that  the  business 
will  be  able  to  pay  the  loan  at  maturity ;  hence  it  is  interested 
to  know  its  financial  condition  three  months  from  now. 

If  it  knows  its  present  financial  condition  and  the  result 
of  its  past  operations,  it  can  estimate  roughly  the  effect  of 
its  future  operations  on  its  present  condition  and  arrive  at 
an  estimate  of  its  financial  condition  three  months  in  the 
future.  The  standard  form  of  the  statement  of  profit  and 
loss  has  been  designed  to  present  to  creditors  and  others  the 
information  with  reference  to  the  past  operations  of  the 
business  which  they  desire.  Since  the  executive  must  pre- 
pare it  for  the  use  of  others,  he  has  learned,  as  in  the  case  of 
the  balance  sheet,  to  use  it  for  his  own  purposes. 


ESTIMATED  BALANCE  SHEET 


335 


Standard  Forms  of  Financial  Statements 

The  balance  sheet  and  the  statement  of  profit  and  loss 
have  become,  therefore,  the  two  standard  reports  which  are 
usually  prepared  by  all  businesses  and  which  are  used  by 
the  creditors,  stockholders,  and  executives  of  the  business 
in  the  making  of  decisions  and  the  formulation  of  policies 
with  reference  to  the  business.  Through  the  influence  of 
national  associations,  such  as  the  American  Bankers'  Asso- 
ciation and  the  National  Association  of  Credit  Men,  as  well 
as  the  writings  and  teachings  of  accountants,  more  or  less 
standard  forms  for  these  statements  ha\^e  been  developed. 
It  is  assumed  that  the  form  and  content  of  these  widely 
used  and  orthodox  statements  are  familiar  to  the  reader. 

Use  of  the  Financial  Reports 

The  standard  form  of  balance  sheet  and  the  standard 
form  of  statement  of  profit  and  loss  show  respectively  the 
present  financial  condition  of  a  business  and  the  results  in 
terms  of  profit  and  loss  of  its  operations  over  a  certain  period 
of  time.    This  information  serves  two  purposes: 

1.  It  indicates  the  efficiency  with  which  the  business  has  been  man- 

aged during  the  past,  and 

2.  It  indicates  the  possible  result  of  its  future  operations. 

The  second  purpose  of  the  information  provided  by  the 
financial  reports  has  not  been  emphasized  by  writers  and 
practitioners,  and  yet  a  little  thought  will  show  that  it  is  the 
primary  purpose  for  which  this  information  is  desired.  It  is 
true  that  these  reports  are  usually  discussed  in  terms  of  past 
results,  but  the  principal  purpose  of  studying  past  results  is 
to  be  able  better  to  control  future  results.  Just  as  the  credi- 
tor desires  a  statement  of  profit  and  loss,  so  that  he  can  esti- 
mate the  changes  in  financial  condition  which  will  probably 
take  place  as  a  result  of  the  future  operations  for  a  certain 


336 


BUDGETARY  CONTROL 


period  of  time — in  the  same  manner  the  executive  is  prima- 
rily interested  in  both  the  balance  sheet  and  statement  of 
profit  and  loss  in  order  that  he  may  be  able  to  judge  whether 
future  operations  will  result  in  favorable  changes  in  the 
financial  condition  of  the  business. 

It  is  true  that  both  the  creditor  and  the  executive  make 
their  estimates  infoiTnally  and  incompletely.  Neither  one 
may  be  conscious  that  he  is  making  such  an  estimate  at  all. 
His  thought  may  proceed  no  farther  than  to  reason  that  the 
operations  for  the  past  period  have  resulted  in  a  profit  and  a 
favorable  financial  condition,  and  if  the  same  policies  are 
followed  during  the  next  period,  equally  favorable  results 
will  follow.  If  the  results  of  the  past  period  are  undesirable, 
he  may  try  to  locate  the  cause  and  determine  some  means  to 
remove  it.  If  he  succeeds  in  making  changes  which  he 
thinks  will  remove  the  difficulties  of  the  past  period,  he  may 
assume  that  the  results  of  the  next  period  will  be  more  satis- 
factory without  working  out  in  detail  what  these  results 
will  be. 

For  instance,  the  executive  may  find  that  his  small  profits 
for  the  year  are  due  to  increased  production  cost,  and  that 
the  increased  cost  is  the  result  of  wasteful  and  inefficient 
methods  of  handling  materials  and  supplies  in  certain  depart- 
ments of  the  factory.  He  changes  the  methods  of  these 
departments  so  as  to  lower  the  cost  of  materials  and  supplies, 
and  assumes  that  as  a  result  he  will  have  a  satisfactory  profit 
without  determining  just  what  the  change  in  profits  will  be. 
If  he  finds  that  the  small  profits  are  due  to  decreased  sales, 
and  the  decreased  sales  are  due  to  the  failure  of  salesmen  in 
specific  territories,  he  may  replace  these  salesmen  with 
those  who  are  thought  to  be  efficient  and  estimate  that  as  a 
result  of  these  changes  favorable  profits  will  be  made. 

In  both  of  these  cases  the  executive  may  carry  his  think- 
ing a  step  farther.    He  may  estimate  the  reduction  in  cost 


ESTIMATED  BALANCE  SHEET 


337 


of  materials  which  will  be  effected  by  the  new  methods,  and 
then  calculate  what  the  profits  of  the  business  will  be  for  the 
next  fiscal  period  if  the  other  results  of  operation  are  the 
same  as  for  the  past  period.  In  the  same  manner  he  may 
estimate  the  increased  sales  which  will  be  secured  from  the 
changes  in  sales  personnel  and  the  consequent  results  in 
profits.  If  he  makes  a  number  of  changes  and  estimates 
the  results  of  each  of  these,  he  is  led  to  make  a  more  or  less 
detailed  estimate  of  the  result  of  future  operations. 

Need  for  Estimated  Financial  Statements 

The  foregoing  discussion  and  illustrations  should  be  sufifi- 
cient  to  show  that  the  standard  forms  of  balance  sheet  and 
statement  of  profit  and  loss  are  used  as  a  basis  of  planning 
future  operations  and  estimating  the  results  of  these  opera- 
tions. It  should  also  be  apparent  that  these  plans  and 
estimates  are  usually  made  in  a  very  informal  manner, 
and  consequently  are  apt  to  be  incomplete  and  inac- 
curate. In  fact,  they  are  little  more  than  "expert  guess- 
work." 

In  the  discussion  of  the  various  departmental  budgets, 
it  has  been  emphasized  that  if  estimates  are  to  be  made 
they  will  be  most  serviceable  if  they  are  prepared  in  a 
systematic,  complete,  and  formal  manner.  In  pursuance 
of  this  policy,  it  is  desirable  that  there  be  prepared  an 
estimated  balance  sheet  or  "budget"  of  assets,  liabilities, 
and  proprietorship,  and  an  estimated  statement  of  profit 
and  loss,  or  "budget"  of  income  and  expense,  in  the  same 
manner  that  there  is  prepared  a  budget  of  sales,  purchases, 
expenses,  etc. 

It  is  the  purpose  of  the  present  chapter  to  discuss  the 
construction  and  use  of  the  estimated  balance  sheet.  The 
estimated  statement  of  profit  and  loss  will  be  discussed  in 
the  chapter  immediately  following. 

22 


338 


BUDGETARY  CONTROL 


Relation  of  the  Departmental  Estimates  to  the  Estimated  Finan- 
cial Reports 

The  departmental  estimates  show  the  contemplated 
operations  of  the  several  departments.  The  profits  of  the 
company  and  its  financial  condition  are  dependent  on  these 
operations.  After  the  departmental  estimates  are  prepared , 
it  is  then  necessary  to  prepare  a  preliminary  estimated 
balance  sheet  showing  the  effect  of  the  contemplated  pro- 
gram on  the  financial  condition  of  the  business,  and  a  pre- 
liminary estimated  statement  of  profit  and  loss  showing  the 
result  of  the  program  in  terms  of  profit  and  loss. 

By  studying  these  two  statements  and  comparing  them 
with  the  statements  at  the  beginning  of  the  period,  it  is 
possible  to  judge  the  desirability  of  the  proposed  program. 
If  the  execution  of  the  proposed  program  will  lead  to  undesir- 
able results,  it  will  be  necessary  to  revise  the  departmental 
estimates.  After  these  revisions  are  made,  the  preliminary 
estimated  financial  reports  should  be  revised,  to  give  efTect 
to  the  changes  in  the  departmental  budgets.  Although  the 
budget  period  may  be  three,  six,  or  twelve  months  in  length, 
it  is  desirable  that  the  estimated  balance  sheet  and  state- 
ment of  profit  and  loss  be  made  so  as  to  show  the  anticipated 
results  at  the  end  of  each  month.  Monthly  comparisons 
can  be  made,  then,  between  the  estimated  and  the  actual 
results. 

In  the  following  discussion  the  method  by  which  the 
estimated  financial  reports  are  made  will  first  be  considered, 
and  then  the  method  by  which  they  are  studied  to  see  if  they 
show  the  necessity  of  a  revision  in  the  departmental  budgets 
will  be  explained. 

The  Estimated  Balance  Sheet 

To  make  the  discussion  of  the  preparation  of  the  esti- 
mated balance  sheet  more  concrete,  a  simple  balance  sheet 


ESTIMATED  BALANCE  SHEET 


339 


NATIONAL  MANUFACTURING  COMPANY 
BALANCE  SHEET 
December  31,  1921 


Current  Assets: 

Cash  5  48,000 

Notes  Receivable   80,000 

Accounts  Receivable   $200,000 

Le55:  Reserve  for  Bad  Debts   4,000 

  196,000 

Inventory': 

Raw  Materials   $40,000 

Goods  in  Process   120,000 

Finished  Goods   560,000 

  720,000 

Accrued  Items   500 

Total  Current  Assets    $1,044,500 

Fixed  Assets: 

Office  Equipment   $  40,000 

Less:  Reserve  for  Depreciation.  .  .  .  8,000 

  $  32,000 

Machinery  and  Equipment .  .    $200,000 

Less:  Reserve  for  Depreciation ....  40,000 

  1 60 ,000 

Buildings   $160,000 

Less:  Reserve  for  Depreciation.  .  .  .  48,000 

  112 ,000 

Land   240,000 

Total  Fixed  Assets .. ,     544, 000 

Deferred  Charges  to  Expense   27,000 

Good-Will....   80,000 

Total  Assets  $1.695.500 

Current  Liabilities: 

Notes  Payable  $  100,000 

Accounts  Payable   1 50,000 

Accrued  Liabilities   10,000 

Total  Current  Liabilities  $  260,000 

Fixed  Liabilities: 

Mortgages  Payable  $  80,000 

Bonds  Payable   80,000 

Total  Fixed  Liabilities   1 60,000 

Proprietorship: 

Capital  Stock  Outstanding  $1,000,000 

Surplus   275,500 

Total  Proprietorship   i ,275.500 

Total  Liabilities  and  Proprietorship  $1.605.500 


Figure  38.    Balance  Sheet 


340 


BUDGETARY  CONTROL 


showing  the  financial  condition  of  a  business  at  the  begin- 
ning of  a  fiscal  period  will  be  given,  and  on  the  basis  of  as- 
sumed departmental  budgets  an  estimated  balance  sheet,  as 
of  the  end  of  the  period,  will  be  prepared.  For  the  sake  of 
simplicity  a  budget  period  one  year  in  length  will  be  assumed, 
and  only  the  estimated  balance  sheet  at  the  end  of  the  year 
will  be  given.  The  reader  will  understand  that  an  estimated 
balance  sheet  at  the  end  of  each  month  is  desirable. 

The  balance  sheet  of  the  National  Manufacturing  Com- 
pany as  of  December  31,  1921,  is  shown  in  Figure  38. 

To  show  the  preparation  of  the  estimated  balance  sheet 
as  of  December  31,  1921,  it  will  be  necessary  to  take  each 
item  which  appears  on  the  balance  sheet  at  the  beginning  of 
the  period  and  see  the  method  by  which  the  changes  which 
wall  occur  in  it  are  determined. 

Cash 

The  cash  which  it  is  estimated  will  be  received  from  the 
operations  of  the  business  during  the  budget  period,  will  be 
shown  by  the  estimate  of  cash  receipts  (Figure  30,  page  308) 
which  is  prepared  as  part  of  the  financial  budget.  The  esti- 
mate of  cash  receipts  does  not  show  the  cash  to  be  received 
from  bank  loans,  for  the  purpose  of  the  estimate  of  cash  re- 
ceipts and  disbursements  is  to  show  the  loans  required.  The 
amount  of  these  loans  can  be  determined  from  the  financial 
program  (Figure  34,  page  318),  which  is  prepared  on  the 
basis  of  the  financial  budget.  The  estimate  of  cash  receipts 
also  does  not  show  the  cash  which  may  be  received  from  new 
financing  such  as  the  sale  of  stock  or  bonds.  The  amount 
of  such  cash  must  be  obtained  by  a  consideration  of  the 
plans  of  the  directors. 

The  estimated  disbursements  for  operating  purposes 
can  be  obtained  from  the  estimate  of  cash  disbursements 
(Figure  31,  page  311).    The  estimate  of  cash  disbursements 


ESTIMATED  BALANCE  SHEET 


does  not  show  the  disbursements  for  paying  bonds  or  retir- 
ing long-term  notes.  Such  disbursements  can  be  easily  de- 
termined from  the  plans  of  the  directors  and  the  terms  under 
which  the  bonds  or  notes  were  issued. 

After  the  estimated  cash  receipts  from  all  sources  and  the 
estimated  cash  disbursements  for  all  purposes  are  deter- 
mined, the  estimated  cash  balance  can  be  determined. 
Although  this  is  the  method  by  which  the  estimated  cash 
balance  is  finally  obtained,  it  is  customary  to  decide  what 
cash  balance  is  deemed  necessary  and  use  this  in  preparing 
the  summary  of  financial  requirements  (Figure  34,  page  318), 
from  which  the  bank  loans  required  are  determined.  Of 
course,  if  the  bank  loans  required  as  shown  by  the  prelimi- 
nary summary  of  financial  requirements  are  larger  than  it  is 
thought  desirable  or  possible  to  obtain,  revisions  are  neces- 
sary, and  in  making  these  revisions  the  estimated  cash  bal- 
ance may  be  cut  dowoi. 

Based  on  the  financial  budget  of  the  National  Manufac- 
turing Company,  it  is  estimated  that  its  cash  balance  on 
December  31,  1922,  will  be  $20,000. 

Notes  Receivable 

To  determine  the  amount  of  the  notes  receivable  which 
will  be  on  hand  at  the  end  of  the  period,  it  is  necessary  to 
consider  the  following: 

(a)  Notes  receivable  on  hand  at  the  beginning  of  the  period. 

(b)  Estimated  notes  receivable  which  will  be  received  in  payment  of 

goods  sold  during  the  period. 

(c)  Estimated  notes  receivable  which  will  be  received  in  payment  of 

accounts  during  the  period. 

(d)  Estimated  cash  receipts  from  notes  receivable  during  the  period. 

It  should  be  apparent  to  the  reader  that  a-{-b-fc— d 
equals  the  notes  receivable  on  hand  at  the  end  of  the  period. 
If  a  business  has  but  a  few  customers,  it  will  be  possible  to 


342 


BUDGETARY  CONTROL 


determine  the  amount  of  b,  c,  and  d  by  considering  each 
customer  separately.  If  there  are  numerous  customers,  it 
may  be  necessary  to  obtain  the  ratio  between  accounts  re- 
ceivable and  notes  receivable  for  the  past  several  years,  and 
assume  that  this  ratio  will  continue  during  the  current  year 
if  no  changes  in  terms  or  of  general  business  conditions  are 
anticipated.  If  new  lines  are  to  be  introduced,  which  are  to 
be  sold  on  different  terms,  or  if  business  conditions  are  such 
that  clients  are  apt  to  give  notes  in  payment  of  accounts  in 
greater  quantities  than  usual,  these  facts  must  be  considered, 
and  the  estimated  ratio  between  notes  receivable  and  ac- 
counts receivable  revised  accordingly.  After  this  ratio  is 
determined,  it  will  be  applied  to  the  estimated  balance  of 
unpaid  claims  against  customers  at  the  end  of  the  period  to 
obtain  the  estimated  notes  receivable  outstanding. 

The  National  Manufacturing  Company  sells  several 
classes  of  products.  Some  of  these  are  sold  on  account,  and 
some  are  sold  on  terms  which  provide  for  the  receipt  of  trade 
acceptances  and  notes  in  payment.  The  tendency  for  the 
past  three  years  has  been  for  an  increase  of  the  sales  of  the 
latter  in  proportion  to  the  former.  The  sales  program  for 
the  year  1922  calls  for  an  increase  in  this  tendency  during 
the  next  year.  It  is  also  anticipated  that  general  business 
conditions  are  such  that  more  than  the  usual  number  of 
notes  will  be  received  from  customers  in  settlement  of  due 
accounts.  It  is  estimated  that  under  these  conditions  the 
notes  receivable  on  hand  on  December  31 ,  1922,  will  amount 
to  $120,000. 

Accounts  Receivable 

The  amount  of  the  accounts  receivable  at  the  end  of  the 
budget  period  is  estimated  in  a  manner  very  similar  to  that 
employed  in  determining  the  amount  of  the  notes  receivable 
as  explained  in  the  preceding  paragraph.    It  is  necessary  to 


ESTIMATED  BALANCE  SHEET 


343 


consider  (a)  the  balance  outstanding  at  the  beginning  of  the 
period ;  (b)  the  accounts  receivable  resulting  from  the  sales 
during  the  period ;  (c)  cash  receipts  from  accounts  receivable 
during  the  period.  It  is  apparent  that  a+b  — c  is  equal  to 
the  accounts  receivable  at  the  end  of  the  period. 

On  this  basis  it  is  estimated  that  the  accounts  receivable 
of  the  National  Manufacturing  Company  on  December  31, 
1922,  will  be  $180,000. 

Reserve  for  Bad  Debts 

The  reser\^e  for  bad  debts  at  the  beginning  of  the  period 
is  2  per  cent  of  the  accounts  receivable,  and  it  is  estimated 
that  the  same  ratio  will  exist  at  the  end  of  the  year.  Con- 
sequently it  is  estimated  that  the  reserve  will  be  $3,600. 

Inventories 

The  inventory  of  raw  materials  at  the  end  of  the  period 
can  be  obtained  from  the  materials  budget,  since  this  budget 
shows  not  only  the  deliveries  to  stock  for  each  month,  but 
also  the  balance  on  hand  at  the  end  of  each  month.  The 
inventory  of  goods  in  process  can  be  determined  by  a  con- 
sideration of  the  following:  (a)  inventory  at  beginning  of 
period ;  (b)  cost  of  the  materials,  labor,  and  manufacturing 
expense  put  into  process  during  the  period ;  (c)  finished  goods 
transferred  from  factory  to  stock  during  the  period.  The 
inventory  of  goods  in  process  at  the  end  of  the  period  is 
equal  to  a+b  — c.  The  items  in  (2)  will  be  obtained  from 
the  estimate  of  raw  material  requirements,  the  labor  budget, 
and  the  manufacturing  expense  budget.  Item  (c)  will  be 
obtained  from  the  finished  goods  budget. 

The  inventory  of  finished  goods  can  be  obtained  by  a 
consideration  of  the  following:  (a)  inventory  at  the  begin- 
ning of  the  period ;  (b)  finished  goods  transferred  from  fac- 
tory to  stock  during  the  period;  (c)  stock  sold  during  the 


344 


BUDGETARY  CONTROL 


period.  The  inventory  of  finished  goods  at  the  end  of  the 
period  is  equal  to  a+b  —  c.  Usually,  in  making  up  the  esti- 
mate of  finished  goods  required,  the  inventory  desired  of 
each  separate  item  at  the  end  of  the  period  is  estimated, 
since  this  inventory  constitutes  a  part  of  the  requirements 
for  the  period.  If  the  inventory  of  the  separate  items 
which  it  is  planned  to  have  is  extended  at  cost  price,  the  total 
inventory  can  be  obtained.  In  some  cases  it  may  be  easier 
to  reduce  the  sales  estimate  by  the  amount  of  the  average 
gross  profit  and  substitute  the  result  in  the  equation  given 
above.  Either  method  may  be  followed  and  approximate 
accuracy  obtained. 

On  the  basis  of  the  present  inventories  and  the  various 
budgets,  it  is  estimated  that  the  inventories  of  the  company 
on  December  31,  1922,  will  be  as  follows: 

Raw  materials   $  70,000 

Goods  in  Process   230,000 

Finished  Goods   1,100,000 

Total   $1,400,000 

Accrued  Income 

The  chief  source  of  accrued  income  is  accrued  interest 
on  notes  receivable.  The  estimated  increase  in  the  amount 
of  the  notes  will  cause  a  corresponding  increase  in  the 
amount  of  this  item.  Accordingly  it  is  estimated  to  be 
$1,000  on  December  31,  1922. 

Fixed  Assets 

The  plant  and  equipment  budget  shows  the  following 
for  each  class  of  fixed  assets :  (a)  balance  of  asset  and  reserve 
for  depreciation  accounts  at  the  beginning  of  the  period; 

(b)  estimated  cost  of  assets  to  be  acquired  during  the  period ; 

(c)  estimated  depreciation  for  the  period  on  both  old  and 
new  assets;  (d)  balance  of  asset  and  depreciation  accounts 


ESTIMATED  BALANCE  SHEET 


345 


at  the  end  of  the  period.  It  is  very  easy,  therefore,  to  obtain 
from  the  plant  and  equipment  budget  the  desired  informa- 
tion for  the  estimated  balance  sheet  with  reference  to  both 
the  fixed  assets  and  the  depreciation  thereon. 

From  the  plant  and  equipment  budget  it  is  estimated 
that  the  fixed  assets  and  reser\^es  for  depreciation  of  the 
company  on  December  31,  1922,  will  be  as  follows: 

Office  Equipment   $  60,000 

Less:  Reserve  for  Depreciation   14,000 

  $  46,000 

Machinery  and  Equipment   $280,000 

Less:  Reserve  for  Depreciation   100,000 

  180,000 

Building   $200,000 

Less:  Reserve  for  Depreciation   58,000 

  142,000 

Land   240,000 

Total  Fixed  Assets   $608,000 


Deferred  Charges  to  Expense 

The  deferred  charges  to  expense  consist  of  organization 
expenses,  unexpired  insurance,  and  prepaid  interest.  The 
organization  expenses  disappear  from  the  balance  sheet, 
since  this  is  the  last  year  of  the  period  over  which  they  are 
being  allocated.  The  unexpired  insurance  can  be  deter- 
mined by  a  consideration  of  (a)  the  insurance  which  it  is 
planned  to  place  during  the  year,  and  (b)  the  insurance  un- 
expired at  the  beginning  of  the  year.  The  latter  can  be 
obtained  from  the  insurance  policy  record,  while  the  former 
must  be  obtained  from  the  estimate  on  insurance.  Usually 
there  is  one  officer  who  is  responsible  for  all  insurance  con- 
tracts. In  many  cases  this  responsibility  is  placed  on  the 
treasurer.  The  responsible  official  will  prepare  an  estimate 
of  the  contracts  to  be  made  and  their  length  of  life.  The 
prepaid  interest  will  arise  largely  from  the  notes  of  custom- 


346 


BUDGETARY  CONTROL 


ers  which  are  discounted.  The  amount  of  the  notes  to  be 
discounted  can  be  determined  from  the  financial  program, 
which  is  prepared  in  connection  with  the  financial  budget. 

It  is  estimated  that  the  deferred  charges  of  the  company 
on  December  31,  1922,  will  be  $35,000. 

Good-Will 

The  book  value  of  the  good-will  will  not  change  during 
the  year. 

Notes  Payable 

The  amount  of  the  notes  payable  at  the  end  of  the  year 
will  depend  on  the  following :  (a)  notes  payable  at  beginning 
of  the  period;  (b)  notes  issued  in  payment  of  merchandise; 
(c)  notes  issued  in  payment  of  accounts;  (d)  notes  issued  to 
bank  for  loans;  (e)  notes  paid  during  the  period.  The 
notes  outstanding  at  the  end  of  the  period  equal  a+b  +  c+ 
d  — e.  The  notes  to  be  issued  to  merchandise  creditors  in 
payment  for  merchandise  can  be  determined  by  a  consid- 
eration of  the  materials  budget.  This  budget  shows  the 
purchases  to  be  made  during  the  period,  classified  under  at 
least  major  groups  or  classes.  Usually  it  is  for  only  certain 
classes  of  merchandise  that  notes  are  given  or  trade  accept- 
ances issued,  and  the  amount  of  these  classes  of  merchan- 
dise which  is  to  be  purchased  can  be  obtained  from  the  ma- 
terials budget. 

If  notes  or  trade  acceptances  are  issued  for  part  of  the 
purchases  in  different  lines,  it  is  then  necessary  to  obtain 
the  ratio  between  the  purchases  made  for  notes  and  the  total 
purchases  during  past  periods,  and  apply  this  percentage 
to  the  estimated  purchases  for  the  current  period.  In  most 
businesses  few,  if  any,  notes  are  issued  in  payment  of  ac- 
counts. If  such  notes  are  issued,  it  is  necessary  to  obtain 
the  ratio  between  them  and  the  total  purchases  on  account, 


ESTIMATED  BALANCE  SHEET 


347 


and  apply  this  ratio  to  the  estimated  purchases  on  account 
for  the  current  period. 

The  amount  of  the  notes  to  be  issued  to  banks  can  be 
obtained  from  the  financial  program  (page  318),  prepared 
in  connection  with  the  financial  budget.  The  disbursements 
made  in  the  payment  of  notes  payable  are  shown  in  the 
financial  program  and  in  the  estimate  of  cash  disbursements. 
In  addition  to  the  notes  discussed  above,  notes  payable 
may  be  issued  to  officers,  employees,  and  friends  of  a  com- 
pany. A  separate  estimate  must  be  made  of  their  amount. 
On  the  balance  sheet  it  is  desirable  to  state  the  notes  issued 
for  separate  purposes  and  to  different  parties  as  separate 
items.  For  the  sake  of  brevity  they  will  be  stated  as  one 
item  in  the  present  case. 

The  notes  payable  of  the  company  as  of  December  31, 
1922,  will  be  $450,000,  according  to  the  estimate. 

Accounts  Payable 

The  amount  of  the  accounts  payable  at  the  end  of  the 
period  will  be  determined  from  the  following:  (a)  accounts 
payable  at  the  beginning  of  the  period ;  (b)  purchases  on  ac- 
count during  the  period;  (c)  payments  made  on  account 
during  the  period.  The  accounts  payable  at  the  end  of 
the  period  equal  a-f-b  — c.  The  amount  of  the  purchases 
on  account  will  be  obtained  from  the  materials  budget. 
The  amount  of  the  payments  on  account  will  be  obtained 
from  the  estimate  of  cash  disbursements. 

The  accounts  payable  of  the  company  as  of  December 
31,  1922,  are  estimated  to  be  $200,000. 

Accrued  Liabilities 

The  principal  items  of  accrued  liabilities  are  accrued 
interest  on  notes  payable  and  accrued  wages.  Since  the 
company  is  planning  to  increase  greatly  the  amount  of  its 


348 


BUDGETARY  CONTROL 


notes  payable,  this  will  result  in  an  increase  in  the  accrued 
interest.  Since  it  also  plans  to  increase  very  much  its  in- 
ventory of  finished  goods,  this  will  result  in  an  increase  in 
production,  with  an  enlarged  labor  force,  which  in  turn 
will  probably  result  in  a  larger  item  of  accrued  wages.  It 
is  estimated  that  the  accrued  wages  and  accrued  interest 
on  December  31,  1922,  will  amount  to  $20,000. 

Mortgages  and  Bonds  Payable 

The  anticipated  increase  in  fixed  assets  will  necessitate 
additional  capital,  and  the  treasurer  recommends  to  the 
board  of  directors  that  the  mortgages  on  real  estate  be  in- 
creased by  $40,000,  and  that  $60,000  additional  bonds  be 
issued.  Accordingly  the  fixed  liabilities  of  the  company  on 
December  31,  1922,  will  be  as  follows:  mortgages  payable 
$120,000,  bonds  payable  $140,000. 

Capital  Stock 

The  enlarged  operations  which  are  planned  for  the  year 
will  necessitate  the  procurement  of  additional  capital.  The 
president  and  the  treasurer  recommend  to  the  board  of  di- 
rectors that  $250,000  of  additional  stock  be  sold.  The  esti- 
mated capital  stock  of  the  company  on  December  31,  1922, 
therefore,  will  be  $1,250,000. 

Surplus 

The  amount  of  the  surplus  at  the  end  of  the  period  will 
be  determined  from  the  following:  (a)  surplus  at  the  begin- 
ning of  the  period ;  (b)  profits  for  the  period ;  (c)  dividends 
to  be  declared.  The  surplus  at  the  end  of  that  period  will 
equal  a+b  — c.  The  profits  for  the  period  are  determined 
from  the  estimated  statement  of  profit  and  loss.  The 
dividends  to  be  paid  will  be  determined  by  the  board  of 
directors.    Taking  these  factors  into  consideration  it  is  esti- 


ESTIMATED  BALANCE  SHEET 


349 


mated  that  the  surplus  of  the  company  on  December  31, 
1922,  will  be  $170,000. 

Interpretation  of  Estimated  Balance  Sheet 

On  the  basis  of  the  information  given  in  the  preceding 
paragraphs,  it  is  possible  to  construct  a  preliminary  esti- 
mated balance  sheet  for  the  National  Manufacturing  Com- 
pany as  of  December  31 ,  1922.  The  contents  of  this  report 
is  shown  in  Figure  39. 

As  previously  explained,  the  purpose  of  the  preliminary 
estimated  balance  sheet  is  to  show  the  effect  on  the  financial 
condition  of  the  business  of  the  proposed  plans  for  the  next 
period,  as  expressed  in  the  departmental  budgets.  After  it 
is  prepared,  it  is  necessary  to  study  it  to  see  whether  it 
shows  a  desirable  tendency,  and,  if  it  does  not,  revisions  in 
the  budgets  should  be  made,  if  possible,  so  as  to  remedy  the 
undesirable  tendency.  The  easiest  way  to  see  the  effect  of 
the  proposed  budgets  is  to  show  the  estimated  balance  sheet 
as  of  the  end  of  the  period  in  comparison  with  the  actual  bal- 
ance sheet  at  the  beginning  of  the  period.  This  comparison 
for  the  National  Manufacturing  Company  is  shown  in 
Figure  39. 

The  most  significant  comparisons  shown  by  Figure  39 
will  be  considered. 

Cash 

It  is  estimated  that  the  cash  balance  at  the  end  of  the 
year  will  be  but  slightly  more  than  40  per  cent  of  the  cash 
balance  at  the  beginning  of  the  year.  A  decrease  in  the 
cash  balance  is  not  in  itself  undesirable.  In  some  cases  it 
may  be  desirable,  for  the  cash  balance  at  the  beginning  of 
the  period  may  have  been  too  large.  The  important  ques- 
tion to  determine  is  whether  the  cash  balance  at  the  end  of 
the  year  is  sufficient.    Although  this  question  cannot  be 


350 


BUDGETARY  CONTROL 


answered  definitely,  since  there  are  no  definite  standards  by 
which  to  judge  the  cash  balance  which  a  business  should 
have,  there  are  indications  that  the  estimated  balance  for 
the  company  is  too  small. 

In  the  first  place  the  current  liabilities  are  $760,000,  and 
it  is  safe  to  assume  that  these  are  maturing  each  day.  The 
current  assets  are  also  presumably  being  converted  into 
cash  every  day,  but  it  is  not  difficult  to  conceive  of  a  situa- 
tion where  the  liabilities  maturing  on  a  particular  day  may 
be  more  than  the  fimds  received  from  current  assets  on  that 
day,  plus  a  cash  balance  of  $20,000.  Then,  of  course,  it  is 
impossible,  or  at  least  impractical,  to  pay  out  the  total 
cash  balance.  The  primary  purpose  of  the  cash  balance  is 
to  take  up  the  possible  slack  between  cash  receipts  and  cash 
disbursements,  and  it  is  unwise  to  reduce  this  balance  to  too 
small  an  amount,  especially  if,  as  in  this  case,  the  excess  of 
current  assets  over  current  liabilities  is  not  large. 

A  more  important  indication  of  the  inadequacy  of  the 
estimated  cash  balance  is  the  ratio  between  the  cash  balance 
and  the  notes  payable.  The  latter  item  is  not  analyzed,  but 
it  is  safe  to  assume  that  it  is  expected  that  a  considerable  part 
of  the  notes  outstanding  on  December  31,  1922,  will  be  in 
the  hands  of  the  bankers  of  the  firm.  Practically  all  banks 
require  that  a  customer  maintain  a  bank  balance  which 
bears  a  certain  ratio  to  the  loans  made  to  the  customer  by 
the  bank.  Many  banks  require  that  the  balance  shall  be 
20  per  cent  of  the  loans  granted  to  the  customer.  If  such  a 
cash  balance  is  required  by  the  bankers  of  this  company, 
its  maximum  bank  loans  on  December  31,  1922,  would  be 
$100,000.  It  is  hardly  to  be  conceived  that  less  than  one- 
fifth  of  the  notes  issued  by  the  firm  are  to  bankers. 

It  is  probable  that  the  estimated  balance  sheet  calls  for 
an  impossible  condition  by  planning  for  larger  bank  loans 
than  the  cash  balance  will  make  possible.    In  any  case  a 


ESTIMATED  BALANCE  SHEET 


COMPARATIVE  BALANCE  SHEET 

FOB  THE 

NATIONAL  MANUFACTURING  COMPANY 

ASSETS 

CriBRENT  Assets: 

1921 

1922 

Cash  

Notes  Receivable  

Less:  Reserve  for  Bad  Debts . 

$  48,000 
■  80,000 

4.000  196,000 

$ 

$  20,000 
120,000 

180,000 
3,600  176,400 

Invcntonest 

Raw  Materials  

Goods  in  Process  

S  40.000 
120.000 

$  70,000 
230,000 
1,100.000  1,400,000 

2  000 

1,000 

$1,717,400 

FiXBD  Assets: 

8,000  $  32,000 

s 

60,000 

14,000  $  46,000 

$200,000 
40,000  160,000 

s 

280,000 

100,000  180,000 

Less:  Depreciation  

48.000  112,000 

$ 

200,000 

58.000  142,000 

240.000 

240,000 

Total  Fixed  Assets  

544,000 

608,000 

Deferred  Charges  to  Espe  <ise.. 

24,000 

35,OOo 

Good-Will  

80.000 

80.000 

$1,694,000 

$2,440,400 

LIABILITIES 

Current  LuBiLrriEs: 

Notes  Payable  

Accounts  Payable  

Accrued  Liabilities  

$  100.000 
150,000 
10,000 

<  540,000 
200,000 
20,400 

Total  Current  Liabilities. . . 

$  260,000 

$  760,400 

Fixed  Lubilities: 

Mortgages  Payable  

Bonds  Payable  

$  80.000 
80.000 

$  120,000 
140,000 

Total  Fixed  Liabilities. 

160,000 

260,000 

Proprietorship: 

Surplus  

$1,000,000 
274,000 

$1,250,000 
170,000 

Total  Liabilities  and  Pro- 

1,274.000 

1,420,000 

$1,694,000 

$2,440,400 

Figure  39.    Comparative  Balance  Sheet,  with  Preliminary  Estimate 


352 


BUDGETARY  CONTROL 


business  doing  the  volume  of  business  which  this  balance 
sheet  indicates,  should  not  at  any  time  be  in  such  a  condi- 
tion as  to  be  unable  to  borrow  more  than  $100,000  from  its 
banks.  The  estimated  statement  of  profit  and  loss  which 
will  be  given  later  will  confirm  the  inadequacy  of  this  cash 
balance.  Revisions  in  the  budgetary  program  which  will 
accomplish  its  increase  will  be  discussed  subsequently. 

Notes  Receivable  and  Accounts  Receivable 

The  notes  receivable  show  an  estimated  increase  of  50 
per  cent,  while  the  accounts  receivable  show  a  decrease. 
This  is  rather  an  unusual  situation,  since  an  increase  in  the 
volume  of  business  should  produce  a  corresponding  increase 
in  both.  In  the  preceding  discussion  of  the  method  of  de- 
termining the  amount  of  the  notes  receivable,  it  has  been  ex- 
plained that  the  statistics  of  past  periods  show  a  tendency  for 
the  sales  for  which  notes  are  received  in  payment  to  increase 
faster  than  the  sales  on  account.  There  may  be  conditions 
under  which  this  tendency  will  not  be  regarded  as  undesir- 
able, but  usually  notes  received  in  payment  of  merchandise 
are  non-interest-bearing  and  are  for  a  considerably  longer 
length  of  time  than  the  usual  credit  period  granted  on  open 
account  sales.  Consequently  the  seller  is  required  to  bor- 
row funds  with  which  to  carry  these  notes  or  must  discount 
them  to  obtain  funds.  In  either  case  the  interest  charge 
must  be  borne  by  him  which  in  turn  reduces  his  profit. 
Unless  a  higher  sales  price  is  obtained  for  goods  sold  on 
notes,  less  profit  is  obtained  usually  than  for  goods  sold  on 
account. 

The  estimated  balance  sheet  shows  such  a  radical  change 
in  the  ratio  of  accounts  receivable  to  notes  receivable,  that  a 
careful  examination  should  be  made  of  the  tendency  shown 
by  the  comparisons  of  past  periods  to  see  whether  the  tend- 
ency for  the  notes  receivable  to  increase  more  than  in  pro- 


ESTniATED  BALANCE  SHEET 


353 


portion  to  the  accounts  receivable  should  be  permitted  to 
continue,  or  whether  strenuous  efforts  should  be  made  to 
correct  it  by  enforcement  of  stricter  credit  terms  or  by  plac- 
ing more  sales  effort  on  other  lines. 

Inventories 

The  estimated  inventories  of  December  31,  1922,  are 
almost  twice  what  the  inventories  are  at  the  beginning  of  the 
year.  The  estimated  increases  in  the  inventories  of  raw 
materials  and  goods  in  process  are  no  doubt  the  result  of  the 
estimated  increase  in  production  which  is  required  to  build 
up  and  maintain  the  large  increase  in  finished  goods  for 
which  the  estimated  balance  sheet  calls.  Such  an  estimated 
increase  in  finished  goods  may  result  from  the  following : 

1.  A  large  increase  in  sales  may  be  estimated  and  this  calls  for  an 

increased  inventory.  Whether  the  increase  called  for  is  jus- 
tified can  be  determined  to  some  extent  by  considering  the 
turnover  shown  by  the  estimated  statement  of  profit  and  loss, 
and  comparing  this  turnover  with  the  turnover  shown  by  pre- 
vious statements. 

2.  It  may  be  due  to  careless  and  inaccurate  planning  on  the  part  of 

the  production  department.  This  department  may  not  esti- 
mate accurately  the  required  inventor}- of  each  item  to  be  man- 
ufactured, not  basing  this  estimate  on  the  estimate  of  sales,  but 
rather  making  a  lump  estimate  of  the  inventor^'  desired. 

A  very  careful  investigation  should  be  made  to  see  (i) 
whether  the  estimated  inventory  is  necessary  in  order  to  meet 
the  estimated  sales;  (2)  whether  it  is  possible  to  finance  such 
an  inventory,  even  if  it  is  necessary  to  meet  estimated  sales; 
and  (3)  whether  it  is  desirable  to  tie  up  so  much  capital  in 
in\'entory,  with  the  consequent  carr>'ing  charges  and  the 
possibility  of  a  large  loss  being  incurred  due  to  falling  prices. 
It  may  be  found  more  profitable  and  better  financial  policy 
to  reduce  sales  and  carry  a  smaller  inventory. 

23 


354 


BUDGETARY  CONTROL 


There  is  usually  great  danger  attendant  on  such  a  rapid 
expansion  as  the  increase  in  the  inventories  indicates  that 
this  company  is  contemplating.  It  is  also  significant  to 
note  that  though  the  notes  receivable  and  accounts  receiva- 
ble have  increased  less  than  8  per  cent,  the  inventory  of  fin- 
ished goods  has  increased  almost  loo  per  cent.  This  would 
seem  to  indicate  that  it  is  planned  to  increase  the  inventory 
of  finished  goods  faster  than  is  required  by  the  sales  program, 
since  increased  sales,  without  a  change  in  terms  or  collection 
methods,  will  result  in  an  increase  in  the  accounts  receivable 
and  notes  receivable. 

A  statement  of  the  suggested  procedure  for  the  company 
to  follow  in  connection  with  its  inventories  will  be  postponed 
until  after  the  estimated  statement  of  profit  and  loss  is  con- 
sidered. 

Fixed  Assets 

The  estimated  balance  sheet  shows  a  considerable  increase 
in  office  equipment,  machinery  and  equipment,  and  build- 
ings. In  determining  the  propriety  of  these  increases,  it  is 
necessary  to  consider  the  following: 

1.  Whether  the  increases  shown  represent  anticipated  expenditures 

which  can  properly  be  chargeable  to  the  asset  accounts.  Care 
must  be  taken  to  see  that  they  do  not  represent  estimated 
appreciation  on  the  assets  or  estimated  expenditures  for  repairs 
or  replacements.  If  these  increases  are  based  on  the  plant 
and  equipment  budget,  it  should  be  easy  to  determine  their 
accuracy. 

2.  Whether  the  estimated  increases  in  these  assets  are  necessary  to 

carry  on  the  contemplated  program  of  the  year. 

3.  Whether,  if  they  are  necessary,  it  will  be  possible  to  finance  them. 

4.  Whether  it  will  be  profitable  to  incur  these  increases  in  order  to 

carry  on  the  contemplated  program. 

The  estimated  depreciation  should  be  investigated  to  see 
if  it  is  calculated  at  the  proper  rate.    The  figures  shown 


ESTIMATED  BALANCE  SHEET 


355 


would  seem  to  be  reasonable  in  view  of  the  estimated  in- 
crease in  assets. 

Deferred  Charges  to  Expense 

The  increase  in  the  deferred  charges  would  seem  to  be 
reasonable  in  view  of  the  estimated  increase  in  value  of  the 
assets  on  which  insurance  should  be  carried  and  the  prob- 
ability of  an  increase  in  prepaid  interest.  To  determine  the 
desirability  of  the  amoimt  of  the  deferred  charges  to  expense, 
it  is  necessary  to  consider  the  advisability  of  incurring  the 
expenses  which  give  rise  to  these  charges. 

Notes  Payable  and  Accounts  Payable 

Turning  to  the  liability  side  of  the  comparative  balance 
sheet,  it  will  be  noticed  that  a  larger  increase  in  the  notes 
payable  is  estimated.  The  notes  payable  of  December  31 
are  estimated  to  be  almost  five  and  one-half  times  the 
amount  outstanding  at  the  beginning  of  the  year.  An  in- 
crease in  the  accounts  payable  is  also  estimated,  but  this 
increase  is  by  no  means  in  proportion  to  the  contemplated 
increase  in  notes  payable.  An  analysis  should  be  made  to 
show  to  whom  it  is  planned  to  issue  these  notes.  It  is  re- 
garded as  good  financial  management  to  borrow  funds  on 
notes  issued  to  banks  and  to  use  these  funds  to  discount 
accounts  payable.  An  inspection  of  the  item  of  purchases 
discount  on  the  comparative  statement  of  profit  and  loss 
which  will  be  shown  in  Figure  40  (page  363) ,  will  ser\^e  to 
show  whether  this  procedure  is  contemplated.  If  it  is,  the 
estimated  purchases  discount  should  show  a  large  increase 
over  the  amount  of  last  year. 

There  are  indications  that  it  is  contemplated  to  con- 
tract large  bank  loans  in  order  to  pay  accounts  payable 
contracted  to  secure  the  large  increase  in  inventories.  If 
this  be  true,  there  is  considerable  doubt  of  the  advisability 


356 


BUDGETARY  CONTROL 


of  the  contemplated  large  increase  in  bank  loans.  In  the 
first  place,  it  is  doubtful  whether  banks  would  loan  the 
amount  called  for  by  the  estimated  balance  sheet  on  the 
strength  of  the  financial  condition  shown  by  this  statement. 
In  the  second  place  it  is  doubtful  if  the  firm  should  contract 
such  a  large  amount  of  loans  in  order  to  carry  large  inven- 
tories. If  the  inventories  are  not  converted  very  rapidly, 
the  firm  may  be  unable  to  meet  the  notes  at  maturity. 

Fixed  Liabilities 

It  is  estimated  that  the  bonds  payable  and  mortgages 
payable  will  both  increase  during  the  year.  Presumably 
the  funds  to  be  secured  from  these  increases  are  to  be  used  in 
making  the  increase  to  the  fixed  assets.  If  the  increases  in 
fixed  assets  are  found  to  be  justifiable,  it  may  not  be  im- 
proper to  increase  the  fixed  liabilities  correspondingly. 
However,  the  more  desirable  procedure  is  for  a  business  to 
increase  its  permanent  assets  out  of  profits.  A  rapidly  ex- 
panding business  will  often  find  this  impossible,  and  if  there 
is  assurance  that  a  rapid  expansion  will  be  profitable,  no 
objection  can  be  made  to  the  procedure  contemplated  by 
this  company. 

It  must  be  remembered,  however,  that  fixed  liabilities 
impose  upon  a  business  fixed  charges  which  must  be  met 
if  the  business  is  to  continue  to  operate,  and  that  fixed 
liabilities  are  not  subject  to  rapid  contraction  as  are  current 
liabilities.  A  business  should  therefore  be  cautious  in 
adopting  a  program  which  necessitates  an  increase  in  its 
fixed  liabilities. 

Capital  Stock 

The  estimated  balance  sheet  shows  an  increase  in  capital 
stock  of  $2 50,000.  This  increase  strengthens  the  indications 
of  the  other  comparisons  that  the  company  is  embarking  on 


ESTIMATED  BALANCE  SHEET 


357 


an  extensive  program  of  expansion.  If  its  plans  are  depend- 
ent on  the  sale  of  stock,  it  should  be  assured,  before  em- 
barking upon  its  year's  program,  that  the  stock  can  be  sold. 
Otherwise  it  may  find  itself  greatly  embarrassed  because 
the  estimated  balance  sheet  shows  that  the  company  has 
used  practically  every  other  available  source  of  additional 
capital. 

Surplus 

The  estimated  balance  sheet  shows  a  large  decrease  in 
the  surplus  for  the  year.  This  decrease  may  result  (a) 
from  a  loss  being  incurred  during  the  year;  (b)  from  the  pay- 
ing of  dividends  in  excess  of  the  profits  of  the  year.  Either 
condition  indicates  an  undesirable  situation.  To  incur  a 
loss  is  always  undesirable.  There  are  times  when  it  may  be 
desirable  to  pay  dividends  from  accumulated  profits,  but 
the  balance  sheet  of  this  company  does  not  indicate  such 
a  procedure  is  desirable  for  it. 

In  the  first  place,  the  surplus  of  the  company  is  not  large 
in  comparison  to  its  capital  stock.  Secondly,  the  company 
is  planning  to  issue  new  stock  and  additional  bonds  to  obtain 
necessary  capital.  It  is  also  planning  to  contract  large 
liabilities  in  the  form  of  notes  payable.  Under  such  condi- 
tions it  is  doubtful  if  it  is  expedient  to  use  funds  to  pay 
dividends  which  are  declared  from  profits  of  preceding  years. 

Ratio  of  Current  Assets  to  Current  Liabilities 

A  final  comparison  which  is  of  considerable  significance 
is  that  of  the  ratio  of  current  assets  to  current  liabilities. 
On  December  31,  1921,  this  ratio  is  slightly  more  than  4  to 
I,  while  the  estimated  balance  sheet  of  December  31,  1922, 
shows  a  ratio  of  only  23^  to  i .  It  can  be  seen,  therefore,  that 
there  is  a  decided  decrease  in  this  ratio.  Although  the 
ratio  on  December  31,  1922,  does  not  in  itself  appear  unfa- 


358 


BUDGETARY  CONTROL 


vorable,  the  tendency  indicated  by  the  decrease  in  this  ratio 
during  the  year  is  decidedly  undesirable.  If  possible, 
changes  should  be  made  to  prevent  this  decided  decrease  in 
this  ratio.  In  any  case,  care  must  be  exercised  to  see  that 
this  tendency  does  not  continue. 

It  is  of  course  realized  that  no  standard  ratio  of  current 
assets  to  current  liabilities  can  be  established.  This  ratio 
will  vary  from  business  to  business,  and  will  vary  in  the  same 
business  at  different  stages  of  the  business  cycle. 


CHAPTER  XXII 


THE  ESTIMATED  STATEMENT  OF  PROFIT 
AND  LOSS 

Contents  of  the  Estimated  Statement  of  Profit  and  Loss 

The  estimated  statement  of  profit  and  loss  is  prepared 
in  the  same  form  as  the  periodical  statement.  Its  contents 
is  classified  into  the  following  principal  groups: 

1.  Returns  from  sales 

2.  Cost  of  goods  sold 

3.  Operating  expenses 

4.  Non-operating  income 

5.  Non-operating  expense 

It  is  necessary  to  discuss  briefly  the  method  of  estimating 
the  amount  of  each  of  these. 

Returns  from  Sales 

The  estimated  sales  for  the  period  are  shown  by  the 
sales  estimate.  The  estimate  shows  the  gross  sales,  and 
for  the  purpose  of  the  estimated  statement  of  profit  and 
loss  it  is  necessary  to  arrive  at  the  net  sales.  This  makes  it 
necessary  to  determine  the  amount  of  the  sales  returns  and 
sales  allowances.  An  estimate  of  these  can  be  made  by  ob- 
taining their  ratio  to  sales  during  past  periods,  and  apply- 
ing this  ratio  to  the  estimated  sales  for  the  current  period. 
If  there  are  conditions  which  will  affect  this  ratio  during  the 
coming  period,  these  w'lW  need  to  be  given  consideration. 

The  estimated  sales  and  the  estimated  returns  and 
allowance  of  the  National  Manufacturing  Company  are 
showTi  in  the  comparative  statement  of  profit  and  loss 
shown  in  Figure  40. 

359 


36o 


BUDGETARY  CONTROL 


Cost  of  Goods  Sold 

In  calculating  the  cost  of  goods  sold  of  a  manufacturing 
business,  several  items  have  to  be  considered.  These  in- 
clude the  beginning  and  ending  inventories  of  finished  goods, 
materials,  and  goods  in  process.  In  addition  it  is  necessary 
to  know  the  purchases  of  materials,  labor,  and  manufactur- 
ing expense.  The  method  of  calculating  the  inventories 
has  been  explained  in  the  discussion  of  the  estimated  balance 
sheet.  The  estimated  purchases  of  materials,  labor,  and 
manufacturing  expense  can  be  taken  from  the  materials, 
labor,  and  manufacturing  expense  budgets,  respectively. 

In  a  mercantile  business  the  problem  is  much  simpler 
than  in  the  manufacturing  business.  It  is  necessary  to 
consider  only  the  beginning  and  ending  inventories  and  the 
purchases  of  finished  goods.  If  a  finished  goods  schedule 
such  as  that  discussed  in  Chapter  XIV  is  prepared,  all  this 
information  can  be  taken  directly  from  it. 

The  estimated  cost  of  goods  of  the  National  Manufactur- 
ing Company  is  shown  in  the  comparative  statement  of 
profit  and  loss  given  in  Figure  40. 

Operating  Expenses 

The  amount  of  each  class  of  expense  can  be  obtained 
from  the  various  expense  budgets.  The  only  difficulty 
which  may  arise  in  this  connection  is  that  the  expense 
classification  shown  by  the  expense  budgets  may  not 
correspond  with  that  usually  sho\vn  on  the  statement  of 
profit  and  loss.  This  is  particularly  true  if  the  expense 
budgets  are  made  according  to  the  classification  of  expenses 
suggested  in  Chapter  XVIII,  For  instance,  under  cor- 
porate and  financial  expenses  will  be  included  items  which 
are  often  shown  as  non-operating  expenses. 

It  is  the  author's  belief  that  some  such  classification  as 
that  suggested  in  the  discussion  of  the  expense  budgets  is 


ESTIMATED  PROFIT  AND  LOSS 


361 


desirable  for  control  purposes,  and  that  it  is  preferable 
that  the  estimated  statement  of  profit  and  loss  show  the 
same  classification.  If  desirable  a  different  classification 
may  be  shown  on  the  financial  statements  submitted  for 
public  use. 

The  statement  presented  below  shows  the  estimated 
expenses  of  National  Manufacturing  Company,  classified 
under  the  principal  headings  suggested  in  Chapter  XVIII. 
The  expense  estimates  will  supply  the  supporting  data  to 
make  possible  a  judgment  as  to  the  propriety  of  these 
amounts. 

Non-Operating  Income 

The  non-operating  income  can  be  obtained  by  simple 
calculations  based  on  the  information  contained  in  the 
various  budgets.  For  instance,  the  purchases  discount  can 
be  estimated  by  applying  the  ratio  of  purchases  discount  to 
the  total  purchases  of  previous  years,  to  the  estimated  pur- 
chases of  the  current  year.  Interest  earned  can  be  cal- 
culated on  the  basis  of  the  sales  estimate  and  the  ratio  of 
interest  received  to  sales  during  preceding  years.  This 
method  is  based  on  the  assumption  that  the  terms  of  sales 
and  rate  of  interest  on  notes  receivable  will  remain  the  same. 
Contemplated  •  changes  in  policy  must  be  given  effect  in 
making  these  estimates. 

Such  changes  are  contemplated  by  the  National  Manu- 
facturing Company,  which  accounts  for  a  decrease  in  the 
amount  of  these  items  on  its  estimated  statement  of  profit 
and  loss,  as  shown  in  Figure  40. 

Non-Operating  Expense 

If  the  expense  classification  previously  suggested  is 
maintained,  there  will  not  be  many  items  under  non-operat- 
ing expense.    Those  that  are  shown  here  can  be  easily 


362 


BUDGETARY  CONTROL 


estimated.  For  instance,  if  it  is  desired  to  show  sales  dis- 
count as  a  non-operating  expense,  its  amount  can  be  esti- 
mated by  applying  the  ratio  of  sales  discount  to  the  total 
sales  during  previous  years,  to  the  estimated  sales  of  the 
current  year. 

Interpretation  of  the  Estimated  Statement  of  Profit  and  Loss 

The  most  convenient  and  effective  way  to  show  the 
effect  of  the  proposed  budgets  on  the  profits  of  the  business 
is  to  show  the  estimated  statement  of  profit  and  loss  as 
of  the  end  of  the  period,  in  comparison  with  the  actual 
statement  of  profit  and  loss  at  the  beginning  of  the  period. 
The  statement  of  profit  and  loss  of  the  National  Manu- 
facturing Company  as  of  December  31,  1 921,  and  its  esti- 
mated statement  of  profit  and  loss  as  of  December  31,  1922, 
are  shown  in  Figure  40.  The  most  important  comparison 
shown  by  the  statements  will  be  considered. 

Sales 

The  estimated  sales  show  an  increase  of  50  per  cent. 
This  in  itself  looks  very  favorable,  but  the  result  of  these 
sales  in  terms  of  profit  and  loss  must  be  considered  before  a 
final  conclusion  can  be  made. 

Turnover 

The  merchandise  turnover  for  the  year  192 1  is  3.4,  while 
for  the  year  1922  it  is  estimated  to  be  only  2.5.  This 
comparison  shows  a  decided  decrease  in  the  rate  of  turnover 
which  should  be  given  careful  consideration.  The  relation 
of  this  decrease  in  turnover  to  the  inventories  will  be  ex- 
plained later  in  this  discussion. 

Gross  Profits  on  Sales 

The  gross  profits  on  sales  in  192 1  are  approximately  123^ 
per  cent  of  sales,  while  the  estimated  gross  profits  for  1922 


ESTIMATED  PROFIT  AND  LOSS 


363 


COMPARATIVE  STATEMENT  OF  PROFIT  AND  LOSS 

FOR  THE 

NATIONAL  MANUFACTURING  COMPANY 

1921 

1922 

$1 

,600,000 

$2,400,000 

16,000 

24,000 

$1,584,000 

$2,376,000 

C08T  OF  Goods  Sold: 

  i 

18,000 

$ 

40,000 

Purchases  

600,000 

962,000 

I  618,000 

$1,002,000 

Raw  Materials,  Inventory  End  of  Period 

40,000 

70,000 

Raw  Materials  Used  

$ 

578,000 

s 

932,000 

Labor  Used  

625,000 

1,130,000 

Manufacturing  Expense  

575,000 

700,000 

$1,778,000 

$2,762,000 

50,000 

120,000 

$1,828,000 

$2 

882,000 

120,000 

230,000 

Cost  of  Goods  Manufactured  

$1,708,000  . 

$2,652,000 

Finished  Goods  Beginning  Inventory 

240,000 

560,000 

$1,948,000 

$3,212,000 

560,000 

1,100,000 

$1,388,000 

$2,112,000 

Gross  Profit  on  Sales  

$ 

196,000 

$ 

264,000 

Oferatino  Expenses: 

1 

44,000 

$ 

85,000 

30,500 

47,500 

25,000 

41,500 

18,000 

23,000 

10,500 

19,000 

$ 

128,000 

$ 

216,000 

$ 

68,000 

$ 

48,000 

Non-Operating  Income  

24,800 

20,800 

$ 

92,800 

$ 

68,800 

31,000 

53,600 

$__ 

61,800 

$ 

15,200 

Figure  40.    Comparative  Statement  of  Profit  and  Loss,  with 
Preliminary  Estimate 


364 


BUDGETARY  CONTROL 


are  only  1 1  per  cent  of  sales.  This  indicates  that  the  esti- 
mated production  cost  of  goods  sold  increases  faster  than 
the  estimated  sales  price  of  sales.  Or  if  falling  prices  are 
anticipated,  it  may  be  estimated  that  the  sales  price  will 
fall  faster  than  the  production  cost.  This  may  be  a  situa- 
tion which  is  unavoidable,  but  careful  scrutiny  should  be 
made  to  determine  some  means  by  which  it  may  be  remedied. 
The  tendency  indicated  by  this  comparison  is  a  dangerous 
one,  and  one  which  is  apt  to  occur  if  there  is  not  close  co- 
operation between  sales  and  production  departments. 

Ratio  of  Selling  Expenses  to  Sales 

The  selling  expenses  are  .027  of  sales  for  the  year  1921, 
but  according  to  the  estimated  statement  of  profit  and  loss 
are  to  be  .035  for  the  year  1922.  This  shows  that  though 
the  sales  are  expected  to  increase,  the  proposed  marketing 
plans  are  such  that  it  will  cost  more  to  secure  each  dollar 
of  sales  than  during  the  last  year.  An  analysis  of  the  sales 
expense  will  probably  show  that  this  increase  is  due  to  the 
estimated  extra  cost  of  salesmen's  salaries  and  expenses  and 
of  advertising.  It  may  be  planned  to  incur  these  increased 
expenses  to  obtain  additional  business  and  build  up  good- 
will for  the  company.  It  may  be  proper  to  increase  these, 
but  the  tendency  for  such  expenses  to  increase  faster  than 
sales  increase  is  a  dangerous  one,  and  care  should  be  taken 
that  it  does  not  continue  too  long. 

Operating  Expenses 

The  total  operating  expenses  for  1921  are  8  per  cent  of 
sales,  while  for  the  year  1922,  it  is  estimated  that  they  will 
be  9  per  cent.  Although  this  increase  is  not  large  it  shows 
an  undesirable  and  a  dangerous  tendency,  and  a  careful 
examination  should  be  made  to  see  if  it  is  possible  to  change 
this  condition  before  the  budgets  are  approved. 


ESTIMATED  PROFIT  AND  LOSS 


365 


Net  Operating  Profit 

The  net  operating  profit  for  192 1  is  4  per  cent  of  sales, 
while  it  is  estimated  to  be  but  2  per  cent  of  sales  for  the 
year  1922.  It  is  also  estimated  to  be  smaller  in  amount  in 
1922  than  in  1 92 1.  This  is  the  most  discouraging  informa- 
tion shown  on  the  comparative  statement  of  profit  and  loss. 
When  it  is  estimated  that  the  sales  will  increase  50  per  cent, 
it  is  decidedly  unsatisfactory  to  find  an  estimated  decrease 
in  net  profit.  It  may  of  course  be  found  that  some  of  the 
expenses  to  be  incurred  during  the  coming  year  are  expected 
to  result  in  increased  business  during  future  years.  If  this 
be  true,  there  may  be  some  excuse  for  the  unprofitable 
showing,  but  a  careful  examination  should  be  made  to 
ascertain  if  this  is  the  situation. 

Non-operating  Expense 

It  is  estimated  that  there  will  be  a  large  increase  in  the 
non-operating  expenses  for  the  year.  This  increase  is 
probably  due  to  the  anticipated  increase  in  interest  result- 
ing from  the  additional  bonds  and  notes  which  are  to  be 
issued,  and  the  increase  in  the  amount  of  the  mortgages 
payable. 

Net  Income 

The  estimated  net  income  for  1922  is  approximately 
one-fourth  of  the  net  income  for  the  year  previous.  This 
indicates  that  the  proposed  program  for  the  year  is  not  a 
proper  one,  since  a  50  per  cent  increase  in  volume  of  busi- 
ness leads  to  a  75  per  cent  decrease  in  net  income. 

Relation  of  Estimated  Balance  Sheet  to  Estimated  Statement  of 
Profit  and  Loss 
If  the  comparative  balance  sheet  given  in  Chapter 
XXI  is  studied  in  connection  with  the  comparative  state- 


366 


BUDGETARY  CONTROL 


ment  of  profit  and  loss  shown  in  this  chapter,  a  few  signifi- 
cant indications  are  shown: 

1.  The  comparative  statement  of  profit  and  loss  con- 
firms the  indications  of  the  comparative  balance  sheet  that 
a  large  increase  in  business  is  contemplated.  It  shows  that 
the  budgets  are  all  based  on  a  policy  of  expansion. 

2.  The  comparative  balance  sheet  shows  a  large  antici- 
pated increase  in  inventory  of  finished  goods  and  an  increase 
which  is  much  larger  proportionally  than  the  anticipated 
increase  in  sales,  as  shown  by  the  comparative  statement  of 
profit  and  loss.  Whereas  it  is  estimated  that  the  sales  will 
increase  50  per  cent,  it  is  estimated  that  the  inventory  of 
finished  goods  will  increase  almost  100  per  cent.  The 
comparative  statement  of  profit  and  loss  shows  a  decrease 
in  the  merchandise  turnover.  It  is  hard  to  conceive  of 
conditions  which  would  necessitate  such  a  change  in  the  rate 
of  turnover  in  one  year.  These  comparisons  show  rather 
conclusively  that  the  proposed  production  program  is  out 
of  harmony  with  the  sales  program  and  should  be  cut  down. 

3.  The  comparative  balance  sheet  shows  an  estimated 
decrease  in  surplus  of  $104,000.  The  comparative  state- 
ment of  profit  and  loss  shows  a  profit  for  the  year  of  $15,200. 
It  is  evident,  therefore,  that  it  is  planned  to  pay  dividends 
which  will  necessitate  the  distribution  of  a  considerable  part 
of  the  accumulated  surplus.  The  financial  condition  of  the 
business,  as  shown  by  the  comparative  balance  sheet, 
indicates  that  such  a  procedure  would  be  unwise. 

Revision  of  Departmental  Estimates 

It  is  very  probable  that  a  study  of  the  estimated  balance 
sheet  and  the  estimated  statement  of  profit  and  loss  would 
lead  to  a  revision  of  the  departmental  estimates  on  which 
these  statements  are  based.  This  revision  is  necessary  for 
three  reasons: 


ESTIMATED  PROFIT  AND  LOSS 


367 


1.  The  estimated  balance  sheet  shows  that  the  contemplated  pro- 

gram for  the  year  will  result  in  the  firm's  showing  an  unsatis- 
factory financial  condition  at  the  end  of  the  year. 

2.  The  estimated  statement  of  profit  and  loss  shows  that  the  con- 

templated program  will  result  in  an  unsatisfactory  profit  for 
the  year. 

3.  The  financial  budget  shows  that  the  financial  requirements  of 

the  proposed  program  would  probably  be  larger  than  the 
firm  could  finance.  As  already  pointed  out,  the  financial 
condition  of  the  firm,  as  shown  by  its  estimated  balance  sheet, 
does  not  warrant  the  procurement  of  the  quantity  of  loans  for 
which  the  balance  sheet  calls. 

Some  of  the  revisions  which  may  possibly  be  made  are : 

1 .  The  sales  program  will  be  scrutinized  very  carefully  to  determine 

if  all  the  sales  for  which  it  calls  can  be  made  profitably.  If 
not,  those  which  are  not  profitable  will  be  eliminated. 

2.  The  sales  program  will  also  be  examined  to  see  if  it  is  not  possi- 

ble to  increase  sales  to  be  made  on  short-term  credit  and  to 
reduce  those  made  on  long-term  credit.  Any  possible  changes 
will  be  made. 

3.  The  estimated  inventory  of  finished  goods  will  be  cut  down  to 

be  in  harmony  with  the  sales  program.  This  will  result  in 
a  decrease  in  the  production  program,  with  a  consequent 
decrease  in  labor,  materials,  and  manufacturing  expense  cost. 

4.  If  possible,  the  plant  and  equipment  program  will  be  cut  down. 

This  will  be  all  the  more  possible  because  of  the  decrease  in  the 
production  program. 

5.  The  proposed  dividend  may  be  passed. 

6.  The  operating  expense  estimates  will  be  reauced,  if  possible,  so 

that  the  ratio  of  operating  expenses  to  sales  will  not  be  in 
excess  of  the  previous  year,  and,  if  possible,  so  that  it  will  be 
smaller. 

7.  Based  on  the  foregoing  revisions,  the  financial  budget  will  be 

revised. 


Preparation  of  the  Estimated  Financial  Reports 

The  preceding  discussion  has  indicated  the  method  by 
which  the  estimated  balance  sheet  and  statement  of  profit 


368 


BUDGETARY  CONTROL 


and  loss  are  prepared  and  the  manner  in  which  they  may 
be  interpreted.  In  order  to  make  the  discussion  as  concrete 
as  possible,  assumed  statements  were  taken  and  an  interpre- 
tation of  these  made.  It  should  be  evident  to  the  reader 
that  such  an  interpretation  may  lead  to  erroneous  con- 
clusions when  taken  by  itself.  The  foregoing  case  is  given  to 
indicate  the  method  by  which  statements  should  be  analyzed 
rather  than  to  emphasize  the  value  of  the  particular  conclusions 
drawn  from  the  analysis. 

There  may  be  a  difference  of  opinion  with  reference  to 
the  placing  of  the  responsibility  for  the  preparation  of  the 
estimated  statements.  It  is  necessary  to  use  the  various 
departmental  estimates  in  their  preparation,  and  the  execu- 
tive in  charge  of  the  budgetary  procedure  is  the  only  one 
to  whom  all  these  come  automatically.  A  saving  of  time 
results,  therefore,  if  this  executive  is  held  responsible  for 
their  preparation.  After  they  are  completed  he  may  well 
submit  them  to  the  controller  and  the  treasurer  for  con- 
sideration and  suggestions. 

The  executive  in  charge  of  the  budgetary  procedure  will 
prepare  preliminary  estimated  financial  statements  and 
submit  them  to  the  budget  committee  at  the  time  he  sub- 
mits the  departmental  estimates  and  the  estimates  of  cash 
receipts  and  disbursements.  After  the  budget  committee 
has  approved  the  departmental  estimates,  he  will  revise 
the  estimated  financial  statements  to  give  effect  to  the 
changes  which  have  been  made  in  the  departmental 
budgets. 

Control  of  the  Estimated  Financial  Statements 

The  estimated  financial  statements,  like  all  other  esti- 
mates, must  be  compared  with  results  obtained  at  frequent 
intervals,  if  effective  control  is  to  be  exercised  over  their 
use.    Both  the  estimated  balance  sheet  and  the  estimated 


ESTIMATED  PROFIT  AND  LOSS 


369 


statement  of  profit  and  loss  should  be  compared  at  the  end 
of  each  budget  period  with  the  actual  balance  sheet  and 
actual  statement  of  profit  and  loss  as  of  that  date.  This 
comparison  will  be  more  significant  if  the  actual  financial 
statements  at  the  beginning  of  the  year  are  included. 


NATIONAL  MANUFACTURING  COMPANY 
Actual  and  Estimated  Balance  Sheet  as  of  the  Dates  Stated 

Actual 
Dec.  31,  1921 

Estimated 
Dec,  31,  1922 

Actual 
Dec.  31,  1922 

Current  Assets 
Deferred  Charges 
Fixed  Assets 
Intangible  Assets 

Total  Assets 

Current  Liabilities 
Fixed  Liabiflttes 
Deferred  Credits 

Total  LiaJbilfties 
Proprietorship 

Total  LfabilTties  and 
Proprietorship 

Figure  41.    Comparison  of  Actual  and  Estimated  Balance  Sheets 


A  report  showing  proper  comparisons  for  the  balance 
sheet  may  be  made  in  the  form  shown  in  Figure  41. 

A  similar  report  can  be  made  on  the  statement  of  profit 
and  loss  in  the  form  shown  in  Figure  42. 

24 


370 


BUDGETARY  CONTROL 


The  reports  shown  in  Figures  41  and  42  should  be  pre- 
pared by  the  executive  in  charge  of  the  budgetary  proce- 
dure and  submitted  to  the  budget  committee  at  the  time 
the  other  budget  reports  are  transferred  to  it. 

The  "General  Budget" 

Both  practitioners  and  writers  sometimes  refer  to  the 
"general  budget."  The  estimated  balance  sheet  and  esti- 
mated statement  of  profit  and  loss  is  the  most  convenient 
form  in  which  to  prepare  the  general  budget.  These  state- 
ments show  the  effect  of  the  prj^^oseS-^rogram,  as  expressed 
in  the  departmental  estimates,  on  the  financial  condition 
and  earnings  of  the  firm,  and  this  is  the  information  which 
the  executives  and  board  of  directors  need  in  order  to 
judge  the  advisability  of  the  contemplated  plans. 

If  the  budget  committee  and  the  board  of  directors 
study  carefully  the  financial  budget  and  the  estimated 
financial  statements,  together  with  departmental  estimates 
which  support  these,  they  should  have  no  difficulty  in  secur- 
ing the  information  necessary  for  effective  administrative 
control. 

Branch  and  Division  Budgets 

Where  a  business  has  branches,  divisions,  or  subsidiary 
companies,  it  may  desire  to  have  separate  budgets  prepared 
for  each.  In  this  case  separate  sales  estimates,  production 
estimates,  plant  and  equipment  estimates,  etc.,  may  be 
prepared  for  each  unit  and  these  may  be  consolidated  to 
form  a  financial  budget  and  estimated  financial  statements 
for  each. 

The  estimates  of  each  unit  will  be  submitted  separately 
to  the  budget  committee,  and  in  addition  they  will  be  com- 
bined to  form  the  estimates  for  the  company  as  a  whole. 
This  procedure  enables  the  budget  committee  and  board  of 


ESTIMATED  PROFIT  AND  LOSS 


371 


NATIONAL  MANUFACTURING  COMPANY 
Actual  and  Estimated  Statements  of  Profit  and  Loss  as  of  the  Dates  Stated 

Actu&l 
1921 

Estimated 
1922 

Actus! 
1922 

GROSS  Sales 

Returns  and  allowances 
Net  Sales 

Cost  of  goods  Sold 

Gross  Profit  on  sales 

Operating  Expenses 
Sellino  Expenses 
Financial  Expenses 
Executive  Expenses 
Corporate  Expenses 

Total  Operating  Expenses 
net  operating  profit 
Non-operating  Income 
Gross  income 
Non-operating  Expense 
NET  Income 

 ~- 

Figure  42.   Comparison  of  Actual  and  Estimated  Statements  of  Profit  and  Loss 


372 


BUDGETARY  CONTROL 


directors  to  judge  better  the  contemplated  program,  since 
they  can  pass  judgment  on  each  unit  separately.  It  also 
facilitates  the  enforcement  of  the  estimates,  since  responsi- 
bility for  the  variations  between  the  estimated  and  the 
actual  can  be  definitely  fixed. 

Summary 

The  purpose  of  the  foregoing  discussion  is  to  explain 
and  illustrate  the  use  of  the  estimated  balance  sheet  and 
estimated  statement  of  profit  and  loss  in  business  planning 
and  administration.  More  particularly  it  attempts  to  show 
their  relation  to  the  general  budgetary  plans  of  the  business. 
The  development  of  the  use  of  financial  reports  as  a  basis 
of  management  may  be  divided  into  three  stages : 

1.  Business  men  learned  to  use  the  balance  sheet  which  shows  them 

where  they  are  at  a  specific  date. 

2.  They  learned  to  use  the  statement  of  profit  and  loss  which  shows 

them  how  they  got  to  where  they  are. 

3.  They  are  just  now  learning  to  use  the  estimated  balance  sheet 

and  estimated  statement  of  profit  and  loss  which  shows  them 
where  they  are  going  and  how  they  are  to  get  there. 

The  slow  growth  of  the  use  of  the  estimated  balance 
sheet  and  estimated  statement  of  profit  and  loss  has  no 
doubt  been  due  in  part  to  the  attitude  maintained  by  public 
accountants  that  the  function  of  the  accountant  is  to  make 
statements  showing  the  results  of  past  operations,  and  not 
to  prophesy  as  to  what  will  happen  in  the  future.  This 
attitude  is  due  probably  to  the  realization  that,  since  they 
are  not  connected  with  the  business,  they  have  no  control 
over  its  future  operations,  and  therefore  cannot  safely  pre- 
dict their  result.  They  feel  that  such  statements  on  their 
part  might  be  used  to  mislead  the  public  and  this  would 
react  to  their  disfavor.  Although  the  public  accountant 
may  be  justified  in  this  attitude  because  of  the  particular 


ESTIMATED  PROFIT  AND  LOSS 


373 


relations  existing  between  him  and  his  cHent,  this  in  no 
way  detracts  from  the  value  of  the  estimated  financial 
statement  as  a  basis  of  managerial  control. 

The  bookkeeper  has  also  failed  to  prepare  estimated 
financial  reports  because  he  makes  up  his  reports  from  the 
accounts,  and  the  accounts  do  not  reflect  the  decisions  of 
the  executives  of  the  company  with  reference  to  results 
expected. 

No  doubt  in  the  not  distant  future  both  the  accountant 
and  the  business  man  will  come  to  realize  that  all  financial 
statements  are  but  estimates,  and  although  estimates  of 
past  results  as  shown  by  the  standard  balance  sheet  and 
statement  of  profit  and  loss  may  be  more  exact,  estimates 
of  future  results  may  be  equally  useful. 


CHAPTER  XXIII 


MANUAL  OF  BUDGETARY  PROCEDURE 

Need  for  Manual 

As  shown  by  the  discussion  in  the  preceding  chapters, 
the  procedure  involved  in  the  preparation  and  execution  of 
the  various  departmental  budgets  is  a  comprehensive  and 
complex  one.  It  requires  the  cooperation  of  the  various 
functional  executives,  and  a  very  definite  coordination  of 
the  activities  of  the  functional  departments.  The  success 
of  the  budgetary  program  is  dependent  on  this  cooperation 
and  coordination.  If  any  part  of  the  procedure  fails,  it  dis- 
rupts the  remainder. 

For  these  reasons  it  is  desirable  that  the  budgetary  pro- 
cedure be  very  carefully  worked  out  and  reduced  to  written 
form,  so  that  all  executives  and  employees  concerned  may 
be  fully  cognizant  of  it.  This  can  be  most  easily  done  by 
the  preparation  of  a  manual  on  budgetary  procedure. 

Contents  of  Manual 

The  contents  of  a  manual  on  budgetary  procedure  will 
vary  from  business  to  business,  depending  on  the  volume 
and  nature  of  the  operations  performed  and  upon  the 
organization  by  which  the  operations  are  carried  on.  In 
a  manufacturing  business  it  is  usually  desirable  that  the 
manual  discuss  the  following: 

1.  Organization  for  Budgetary  Control 

2.  The  Sales  Budget 

3.  The  Production  Budget 

4.  The  Labor  Budget 

5.  The  Manufacturing  Expense  Budget 

374 


MANUAL  OF  BUDGETARY  PROCEDURE 


375 


6.  The  Materials  Budget 

7.  The  Plant  and  Equipment  Budget 

8.  The  Expense  Budgets 

9.  The  Financial  Budget 

10.  The  Estimated  Financial  Statements 

Illustration  of  Manual 

To  show  concretely  the  possible  contents  of  a  manual 
on  budgetary  procedure,  there  is  given  below  the  manual 
of  a  manufacturing  company.  The  company  has  sales  of 
about  $6,000,000  a  year.  Part  of  the  product  of  the  com- 
pany is  sold  direct  to  the  consumer,  while  the  remainder  is 
sold  to  merchants.  Branches  are  used  to  market  part  of  the 
goods. 

The  president,  who  is  also  treasurer,  does  not  reside  in 
the  city  where  the  company  is  located  but  maintains  an 
active  interest  in  its  affairs.  The  assistant  treasurer  is  gen- 
eral manager;  the  other  principal  executives  are  the  sales 
manager  and  works  manager.  The  assistant  to  the  general 
manager  serves  as  office  manager  and  head  of  the  account- 
ing and  statistical  departments.  The  company's  accounting 
period  is  four  weeks  and  its  budget  period  is  three  accounting 
periods. 

I.   Organization  for  Budgetary  Control 

1.  The  President 

The  President  of  the  Company  is  to  have  direct  control  of  all  matters 
pertaining  to  the  budgetary  program.  All  officers  to  whom  authority  is 
delegated  in  this  manual  are  acting  as  his  agents  and  are  responsible  to  him 
for  the  proper  performance  of  the  duties  delegated  to  them.  In  all  cases 
of  disagreement  between  departments  with  reference  to  the  coordination  of 
estimates,  the  decision  of  the  President  will  be  final. 

2.  The  General  Manager 

The  General  Manager  will  be  the  representative  of  the  President  in  all 
matters  pertaining  to  the  budgetary  program  and  will  have  such  authority 
in  connection  therewith  as  the  President  may  see  fit  to  delegate  to  him. 


376 


BUDGETARY  CONTROL 


In  all  matters  so  delegated,  the  decision  of  the  General  Manager  will  have 
the  same  authority  as  that  of  the  President. 

3.  The  Budget  Committee 

The  General  Manager,  the  Works  Manager,  and  the  Sales  Manager 
will  constitute  a  Budget  Committee  which  will  have  supervision  of  the 
budgetary  program.  The  Assistant  to  the  General  Manager  will  be  secre- 
tary of  this  committee. 

Under  the  authority  and  direction  of  the  President,  the  Budget  Com- 
mittee is  to  consider  all  departmental  estimates  and  to  make  such  changes 
and  revisions  as  it  may  think  desirable.  No  estimate  is  to  be  effective  until 
it  has  received  the  approval  of  the  Budget  Committee.  The  Committee 
will  receive  all  estimates  from  the  Assistant  to  the  General  Manager  and 
will  transmit  the  estimates  as  approved  by  it  to  him.  In  case  the  Budget 
Committee  cannot  agree  with  reference  to  any  estimate,  the  question  in 
dispute  is  to  be  submitted  to  the  President  and  his  decision  will  be  final. 

In  the  consideration  of  the  departmental  estimates,  the  Budget  Com- 
mittee may  call  on  departmental  heads  to  explain  the  reasons  for  the  varia- 
tions in  their  estimates  from  the  estimates  of  past  periods. 

The  Committee  will  receive  through  the  Assistant  to  the  General  Man- 
ager periodic  reports  showing  comparisons  of  the  performance  for  the  past 
period  with  the  estimated  performance  of  that  period.  On  the  basis  of 
these  reports,  it  may  make  revisions  in  the  budgets  for  the  remainder  of 
the  budget  period,  if  it  deems  such  revisions  necessary. 

4.  The  Assistant  to  the  General  Manager 

Under  the  authority  and  direction  of  the  General  Manager,  the  Assist- 
ant to  the  General  Manager  will  have  general  control  and  supervision  over 
the  preparation  and  execution  of  the  budgetary  program.  His  general 
duties  are  outlined  in  the  several  sections  of  this  manual. 

These  duties  may  be  summarized  as  follows: 

(1)  To  receive  from  the  departmental  heads  the  periodic  estimates 

as  provided  for  in  this  manual. 

(2)  To  prepare  from  these  estimates  (a)  estimate  of  cash  receipts, 

(b)  estimate  of  cash  disbursements,  (c)  estimated  balance 
sheet,  and  (e)  estimated  statement  of  profit  and  loss. 

(3)  To  transmit  all  the  estimates  to  the  Budget  Committee  with 

such  recommendations  as  he  may  think  necessary. 

(4)  To  receive  from  the  Budget  Conunittee  the  estimates  as  ap- 

proved and  to  transmit  these  to  the  departmental  heads. 


MANUAL  OF  BUDGETARY  PROCEDURE  37/ 


(5)  To  receive  periodic  reports  prepared  by  the  operating  depart- 

ments or  the  accounting  department  showing  the  depart- 
mental performance  for  the  month. 

(6)  To  transmit  the  periodic  reports  to  the  Budget  Committee 

showing  the  comparison  between  the  estimated  performance 
and  the  actual  performance  for  the  period  for  each  depart- 
ment, and  to  make  such  recommendations  as  he  may  deem 
necessary'. 

(7)  To  transmit  to  departmental  heads  any  revisions  in  the  original 

estimates  w  hich  have  been  made  by  the  Budget  Committee. 

(8)  To  recommend  to  the  General  IVIanager  and  to  the  Budget 

Committee  such  changes  in  the  budgetary  procedure  as  he 
may  deem  desirable. 

He  has  the  implied  authority  to  do  all  things  which  are  necessary  to  the 
proper  performance  of  these  duties. 

5.   The  Departmental  Heads 

The  executive  heads  of  the  various  departments  are  responsible  for  the 
preparation  of  the  estimates  of  their  departments  at  the  time  and  in  the 
manner  prescribed  in  this  manual.  They  are  also  responsible  for  the  prep- 
aration of  the  reports  called  for  in  this  manual.  Any  recommendations 
which  any  departmental  executive  desires  to  make  with  reference  tochanges 
in  budgetary  procedure  will  be  transmitted  in  writing  to  the  Assistant  to 
the  General  Manager.  It  will  be  referred  by  him  to  the  Budget  Committee 
for  consideration. 

The  responsibility  for  the  preparation  of  the  departmental  estimate  and 
the  periodic  report  is  in  each  case  placed  upon  the  head  of  the  department. 
He  may  employ  his  assistants  in  their  preparation  at  his  discretion,  but  the 
responsibility  rests  on  the  executive  head  in  each  case. 

n.   The  Sales  Budget 

I .   Preparation  of  Sales  Estimate 

The  Sales  Manager  will  prepare  for  each  budget  period  the  estimate  of 
the  sales  for  that  period.  In  the  preparation  of  this  estimate  he  will  take 
into  consideration: 

(1)  The  sales  of  past  periods 

(2)  The  present  market  conditions 

(3)  The  contemplated  plans  and  policies  of  the  business  for  future 

periods 


378 


BUDGETARY  CONTROL 


2.  Form  of  Estimate 

The  estimate  of  sales  will  be  made  in  such  form  as  to  show  the  antici- 
pated sales  to : 

(1)  Hospitals 

(2)  Merchants 

It  will  also  show  the  anticipated  sales  of  each  principal  grade  of  goods 
sold.  The  first  classification  is  necessary  in  order  that  the  financial  budget 
may  be  made,  since  the  sales  to  hospitals  are  of  difYerent  terms  than  the 
sales  to  merchants.  The  second  classification  is  necessary  in  order  that 
production  may  be  planned  so  as  to  have  on  hand  the  proper  quantity  of 
the  different  grades.  A  form  to  be  used  in  the  submission  of  the  sales  esti- 
mate will  be  provided  by  the  Assistant  to  the  General  Manager. 

3.  When  Submitted 

The  Sales  Manager  will  transmit  the  sales  estimate  with  his  approval 
to  the  Assistant  to  the  General  Manager  on  or  before  the  first  day  of  the 
third  week  preceding  the  beginning  of  the  budget  period. 

4.  Procedure  by  the  Assistant  to  the  General  Manager 

The  Assistant  to  the  General  Manager  will  transmit  a  copy  of  the 
sales  estimate  to  the  Works  Manager  within  two  days  after  the  receipt  of 
the  original  estimate  from  the  Sales  Manager.  He  will  transmit  the  origi- 
nal estimate,  together  with  all  the  other  estimates  called  for  in  this  manual, 
to  the  Budget  Committee  on  or  before  the  first  day  of  the  first  week  preced- 
ing the  beginning  of  the  budget  period. 

5.  Approval  by  the  Budget  Committee 

The  Budget  Committee  will  make  such  revisions  as  it  thinks  necessary 
in  the  sales  estimate,  and  will  transmit  the  revised  estimate  with  its  ap- 
proval to  the  Assistant  to  the  General  Manager  within  two  days  after  it 
receives  this  estimate.  In  making  its  revisions  the  Budget  Committee  will 
make  specific  changes  of  particular  amounts  instead  of  making  a  percent- 
age revision  of  the  estimate  as  a  whole. 

6.  Transmission  to  the  Selling  Department 

The  Assistant  to  the  General  Managerwill  transmit  the  revised  estimate 
to  the  Sales  Department  immediately  upon  its  receipts  from  the  Budget 
Committee.  This  estimate  as  revised  and  approved  by  the  Budget  Com- 
mittee will  constitute  the  budget  of  the  sales  department  for  the  next  budget 


MANUAL  OF  BUDGETARY  PROCEDURE 


379 


period.  Copies  of  this  estimate  should  be  sent  by  the  Sales  Department  to 
the  Manager  of  each  branch,  indicating  the  quota  of  the  branch  based  on 
this  estimate. 

7.  Periodic  Report  from  the  Statistical  Department 

At  the  end  of  each  period  the  statistical  department  will  send  to  the 
Assistant  to  the  General  Manager  a  report  showing  the  sales  made  during 
the  period.  This  report  will  be  forwarded  on  or  before  the  fifth  working 
day  of  the  period  following  the  period  for  which  it  is  made. 

8.  Periodic  Report  to  the  Budget  Committee 

On  or  before  the  tenth  day  of  each  period,  the  Assistant  to  the  General 
Manager  will  transmit  to  the  Budget  Committee  a  report  showing  a  com- 
parison of  the  estimated  and  actual  sales  for  the  past  period.  He  will  ac- 
company this  report  with  any  recommendations  which  he  may  think  de- 
sirable. 

9.  Revision  of  Sales  Budget  by  Budget  Committee 

On  or  before  the  twelth  day  of  the  period,  the  Budget  Committee  will 
consider  the  report  received  from  the  Assistant  to  the  General  Manager, 
and  will  make  such  changes  as  it  deems  desirable  in  the  sales  budget  for 
the  remainder  of  the  budget  period.  These  changes  will  be  communicated 
to  the  sales  department  by  the  Assistant  to  the  General  Manager  on  or  be- 
fore the  fifteenth  day  of  the  period. 

III.    The  Production  Budget 
I.    Estimate  OF  Finished  Goods 

On  or  before  the  third  day  of  the  third  week  preceding  the  beginning  of 
the  budget  period,  the  Works  Manager  will  receive  from  the  Assistant  to 
the  General  Manager  the  estimate  of  sales  prepared  by  the  Sales  Manager. 
Based  on  this  estimate  the  Works  Manager  will  prepare  an  estimate  of  the 
finished  goods  which  must  be  produced  in  the  next  budget  period  to  meet 
sales  demands.  In  making  this  estimate  the  estimated  inventory  of  fin- 
ished goods  on  hand  at  the  beginning  of  the  period  and  the  desired  inven- 
tory of  finished  goods  at  the  end  of  the  period  will  be  taken  into  consid- 
eration. The  requirements  of  the  sales  department  for  the  period  plus  the 
estimated  inventory  at  the  end  of  the  period,  minus  the  estimated  inven- 
tory at  the  beginning  of  the  period,  will  equal  the  estimated  production  of 
finished  goods  for  the  period. 


380 


BUDGETARY  CONTROL 


2.  Transmission  to  the  Assistant  to  the  General  Manager 

The  Works  Manager  will  transmit  the  estimate  of  production  as  pre- 
pared under  the  preceding  section,  to  the  Assistant  to  the  General  Manager 
within  one  week  after  the  receipt  of  the  sales  estimate  from  the  Assistant 
to  the  General  Manager. 

3.  Approval  by  the  Budget  Committee 

The  Assistant  to  the  General  Manager  will  transmit  the  estimate 
of  production  to  the  Budget  Committee  on  or  before  the  first  day  of 
the  first  week  preceding  the  beginning  of  the  budget  period.  He  may  ac- 
company this  estimate  with  such  suggestions  or  recommendations  as  he  may 
think  desirable.  The  Budget  Commit  tee  will  make  such  changes  as  it  may 
deem  desirable  in  the  estimate,  and  return  it  with  the  Committee's  approval 
to  the  Assistant  to  the  General  Manager  within  two  days  after  its  receipt 
by  the  Committee.  The  Assistant  to  the  General  Manager  will  imme- 
diately transmit  it  to  the  Works  Manager. 

4.  Periodic  Report  from  the  Production  Department 

At  the  end  of  each  period,  the  Works  Manager  will  send  to  the  Assist- 
ant to  the  General  Manager  a  report  showing  the  production  for  the  period. 
This  report  will  be  forwarded  on  or  before  the  fifth  working  day  of  the' 
period  following  the  period  for  which  it  is  made. 

5.  Periodic  Report  to  the  Budget  Committee 

On  or  before  the  tenth  day  of  each  period,  the  Assistant  to  the  General 
Manager  will  transmit  to  the  Budget  Committee  a  report  showing  a  com- 
parison of  the  estimated  with  the  actual  production  for  the  past  period. 
He  will  accompany  this  report  with,  any  recommendations  which  he  may 
think  desirable. 

6.  Revision  of  Production  Budget  by  Budget  Committee 

On  or  before  the  twelfth  day  of  the  period,  the  Budget  Committee  will 
consider  the  report  received  from  the  Assistant  to  the  General  Manager 
and  will  make  such  changes  as  it  deems  desirable  in  the  production  budget 
for  the  remainder  of  the  period.  These  changes  will  be  communicated  to 
the  Works  Manager  by  the  Assistant  to  the  General  Manager. 

IV.    The  Labor  Budget 
I .    Estimate  of  Labor  Cost 

On  or  before  the  tenth  day  preceding  the  beginning  of  the  budget  period, 
the  Works  Manager  will  send  to  the  Assistant  to  the  General  Manager  an 


MANUAL  OF  BUDGETARY  PROCEDURE  381 


estimate  of  the  cost  of  factory  labor  for  each  month  of  the  next  budget  period. 
This  estimate  will  be  based  on  the  estimate  of  production  which  is  pre- 
pared by  the  production  department  in  the  manner  indicated  in  Section  III 
of  this  manual.  The  Works  Manager  will  be  assisted  by  the  Employment 
Department  in  the  preparation  of  this  estimate.  The  estimate  of  labor 
cost  will  be  made  on  a  form  provided  by  the  Assistant  to  the  General  Man- 
ager.   It  will  have  the  following  columnar  headings: 

(1)  Department 

(2)  Saine  period  last  year 

(3)  Average  for  last  four  budget  periods  preceding  the  one  during 

which  the  budget  is  prepared 

(4)  Estimated  cost  for  this  period 

(5)  Distribution: 

(a)  First  period 

(b)  Second  period 

(c)  Third  period 

Columns  (2)  and  (3)  will  be  filled  in  by  the  Assistant  to  the  General 
Manager  prior  to  sending  the  form  to  the  Works  Manager. 

2.  Approval  by  the  Budget  Committee 

On  or  before  the  first  day  of  the  first  week  preceding  the  beginning  of 
the  budget  period,  the  Assistant  to  the  General  Manager  will  transmit  the 
estimate  of  labor  costs  as  prepared  by  the  Works  Manager  to  the  Budget 
Committee,  with  such  recommendations  as  he  may  deem  necessary.  The 
Budget  Committee  will  make  such  changes  as  it  may  deem  expedient,  and 
return  the  estimate  with  its  approval  to  the  Assistant  to  the  General  IVIan- 
ager  within  two  days  after  its  receipt  by  the  Committee. 

The  Assistant  to  the  General  Manager  will  return  the  estimate  of  labor 
cost  as  approved  by  the  Budget  Committee,  to  the  Works  Manager  imme- 
diately upon  its  receipt  from  the  Committee. 

3.  Periodic  Report  on  Labor  Costs 

On  or  before  the  eighth  day  of  each  period,  the  Works  Manager  will 
send  to  the  Assistant  to  the  General  Manager  a  report  showing  the  cost  of 
factory  labor  for  the  preceding  period.  The  Assistant  to  the  General  Man- 
ager will  supply  the  form  for  the  submission  of  this  report. 

On  or  before  the  tenth  day  of  the  period,  the  Assistant  to  the  General 
Manager  will  transmit  a  report  to  the  Budget  Committee  showing  a  com- 
parison between  the  estimated  labor  costs  for  the  past  period  and  the  actual 
costs  as  reported  by  the  \\'orks  Manager.    If  the  Budget  Committee  de- 


382 


BUDGETARY  CONTROL 


sires  to  make  any  recommendations  to  the  Production  Department  with 
reference  to  labor  cost  during  the  remainder  of  the  budget  period,  these 
recommendations  will  be  communicated  to  the  Works  Manager  through 
the  Assistant  to  the  General  Manager  on  or  before  the  twelfth  day  of  the 
period. 

V.    Manufacturing  Expense  Budget 

1.  Estimate  of  Manufacturing  Expense 

On  or  before  the  tenth  day  preceding  the  beginning  of  the  budget  period, 
the  Works  Manager  will  send  to  the  Assistant  to  the  General  Manager  an 
estimateof  manufacturing  expense  for  each  month  of  the  next  budgetperiod. 
In  preparing  this  estimate  he  will  be  assisted  by  the  cost  accounting 
department.  This  estimate  will  be  based  on  the  estimate  of  production 
which  is  prepared  by  the  production  department  in  the  manner  indicated  in 
Section  III  of  this  manual.  The  estimate  of  manufacturing  expense  will 
be  made  on  a  form  provided  by  the  Assistant  to  the  General  Manager.  It 
will  have  the  following  columnar  headings: 

(1)  Department 

(2)  Same  period  last  5^ear 

(3)  Average  for  last  four  budget  periods  preceding  the  one  during 

which  the  budget  is  prepared 

(4)  Estimated  cost  for  this  period 

(5)  Distribution: 

(a)  First  period 

(b)  Second  period 

(c)  Third  period 

Columns  (2)  and  (3)  will  be  filled  in  by  the  Assistant  to  the  General 
Manager  prior  to  sending  the  form  to  the  Works  Manager. 

2.  Approval  by  the  Budget  Committee 

On  or  before  the  first  day  of  the  first  week  preceding  the  beginning  of 
the  budget  period,  the  Assistant  to  the  General  Manager  will  transmit  the 
estimate  of  manufacturing  expense  as  prepared  by  the  Works  Manager  to 
the  Budget  Committee,  with  such  recommendations  as  he  may  deem  neces- 
sary. The  Budget  Committee  will  make  such  changes  as  it  may  deem 
expedient  and  return  the  estimate  with  its  approval  to  the  Assistant  to  the 
General  Manager  within  two  da>'s  after  its  receipt  by  the  Committee. 

The  Assistant  to  the  General  Manager  will  return  the  estimate  of  man- 
ufacturing expense  as  approved  by  the  Budget  Committee  to  the  Works 
Manager  immediately  upon  its  receipt  from  the  Committee. 


MANUAL  OF  BUDGETARY  PROCEDURE  383 


3.    Periodic  Report  on  Manufacturing  Expense 

On  or  before  the  eighth  day  of  each  period,  the  Accounting  Department 
will  send  to  the  Assistant  to  the  General  Manager  a  report  showing  the 
manufacturing  expense  for  the  preceding  period.  The  Assistant  to  the 
General  Manager  will  supply  the  form  for  the  submission  of  this 
report. 

On  or  before  the  tenth  day  of  the  period,  the  Assistant  to  the  General 
Manager  will  transmit  a  report  to  the  Budget  Committee  showing  a  com- 
parison between  the  estimated  manufacturing  expenses  for  the  past  period 
and  the  actual  costs  as  reported  by  the  Accounting  Department,  If  the 
Budget  Committee  desires  to  make  any  recommendations  to  the  Produc- 
tion Department  with  reference  to  manufacturing  expense  during  the  re- 
mainder of  the  budget  period,  these  recommendations  will  be  communi- 
cated to  the  Works  Manager  through  the  Assistant  to  the  General  Manager 
on  or  before  the  twelfth  day  of  the  period. 

VI.    The  Materials  Budget 
I .   Estimate  of  Cost  of  Purchases 

The  Works  Manager  will  prepare  an  estimate  of  the  materials  required 
for  each  budget  period.  This  estimate  will  be  based  on  the  estimate  of 
production  prepared  by  the  Works  Manager  as  outlined  in  Section  III  of 
this  manual.  The  Works  Manager  will  transmit  the  estimate  of  materials 
required  to  the  Assistant  to  the  General  Manager  on  or  before  the  tenth  day 
preceding  the  beginning  of  the  budget  period.  The  Assistant  to  the  Gen- 
eral Manager  will  transmit  the  estimate  immediately  to  the  General  Pur- 
chasing Agent.  On  receipt  of  the  estimate  of  raw  materials  requirements, 
the  General  Purchasing  Agent  will  prepare  an  estimate  of  purchases  to  be 
made  during  the  budget  period.  The  General  Purchasing  Agent  will  make 
this  estimate  on  the  form  supplied  by  the  Assistant  to  the  General  Manager, 
which  will  contain  the  following  columnar  headings: 

(1)  Item 

(2)  First  Period : 

(a)  Estimated  inventory  at  beginning  of  period 

(b)  Estimated  purchases 

(c)  Estimated  inventory  at  end  of  period 

(d)  Estimated  cash  disbursements  for  purchases  made  during 

this  period 

(e)  Estimated  cash  disbursements  for  purchases  made  in  pre- 

vious periods 


384 


BUDGETARY  CONTROL 


(3)  Second  Period: 

(a)  Estimated  inventory  at  beginning  of  period 

(b)  Estimated  purchases 

(c)  Estimated  inventory  at  end  of  period 

(d)  Estimated  cash  disbursements  for  purchases  made  dur- 

ing this  period 

(e)  Estimated  cash  disbursements  for  purchases  made  during 

previous  period 

(4)  Third  Period: 

(a)  Estimated  inventory  at  beginning  of  period 

(b)  Estimated  purchases 

(c)  Estimated  inventory  at  end  of  period 

(d)  Estimated  cash  disbursements  for  purchases  made  during 

this  period 

(e)  Estimated  cash  disbursements  for  purchases  made  in 

previous  periods 

The  General  Purchasing  Agent  will  transmit  this  estimate  to  the  Assist- 
ant to  the  General  Manager  on  or  before  the  last  day  of  the  second  week 
preceding  the  beginning  of  the  budget  period. 

2.  Approval  By  the  Budget  Committee 

The  Assistant  to  the  General  Manager  will  at  once  transmit  the  esti- 
mate of  purchases  to  the  Budget  Committee.  The  Budget  Committee  will 
make  any  changes  it  may  deem  necessary,  and  return  the  revised  estimate 
with  its  approval  to  the  Assistant  to  the  General  Manager  within  two  days 
after  its  receipt  by  the  Budget  Committee.  The  Assistant  to  the  General 
Manager  will  send  the  estimate  of  purchases  as  approved  by  the  Budget 
Committee  to  the  Purchasing  Agent  immediately  upon  its  receipt  from  the 
Budget  Committee. 

3.  Periodic  Report  on  Purchases 

At  the  end  of  each  period,  the  Assistant  to  the  General  Manager  will 
make  a  report  to  the  Advisory  Committee  showing  the  actual  purchases 
of  the  period  compared  with  the  estimated  purchases  and  the  actual  inven- 
tory at  the  end  of  the  period  compared  with  the  estimated  inventory  at  the 
end  of  the  period. 

This  report  will  be  submitted  to  the  Budget  Committee  on  or  before  the 
tenth  day  of  the  period.  If  the  Budget  Committee  desires  to  make  any 
changes  in  the  purchases  budget  for  the  remainder  of  the  budget  period, 


MANUAL  OF  BUDGETARY  PROCEDURE 


385 


it  will  communicate  its  directions  to  the  General  Purchasing  Agent  through 
the  Assistant  to  the  General  Manager  on  or  before  the  twelfth  day  of  the 
period. 

VII.    Plant  and  Equipment  Budget 

1 .  Estimate  of  Plant  and  Equipment  Cost 

On  or  before  the  tenth  day  preceding  the  beginning  of  the  budget  period, 
the  Works  Manager  will  send  to  the  Assistant  to  the  General  Manager  an 
estimate  of  the  expenditures  for  plant  and  equipment  for  each  month  in 
the  next  budget  period.  This  estimate  will  be  submitted  on  a  fonn  pre- 
pared by  the  Assistant  to  the  General  Manager. 

2.  Approval  by  Budget  Committee 

On  or  before  the  first  day  of  the  first  week  preceding  the  beginning  of 
the  budget  period,  the  Assistant  to  the  General  Manager  will  transmit  the 
estimate  of  plant  and  equipment  expenditures  as  prepared  by  the  Works 
Manager  to  the  Budget  Committee,  with  such  recommendations  as  he  may 
deem  necessary.  The  Budget  Committee  will  make  such  changes  as  it  may 
deem  expedient,  and  return  the  estimate  with  its  approval  to  the  Assistant 
to  the  General  Manager  within  two  da}'s  after  the  receipt  of  the  estimate 
by  the  Committee.  The  Assistant  to  the  General  Manager  will  immedi- 
ately transmit  the  estimate  as  approved  by  the  Budget  Committee  to  the 
Works  Manager. 

3.  Periodic  Report  on  Plant  and  Equipment  Expenditures 

On  or  before  the  eighth  day  of  each  period,  the  Accounting  Depart- 
ment will  send  to  the  Assistant  to  the  General  Manager  a  report  show- 
ing the  expenditures  for  plant  and  equipment  during  the  past  period. 
The  Assistant  to  the  General  Manager  will  supply  the  form  for  this 
report. 

On  or  before  the  tenth  day  of  the  period,  the  Assistant  to  the  General 
Manager  will  transmit  a  report  to  the  Budget  Committee  showing  a  com- 
parison between  estimated  plant  and  equipment  expenditures  for  the  past 
period  and  the  actual  expenditures  as  reported  by  the  Accounting  Depart- 
ment. If  the  Budget  Committee  desires  to  make  any  recommendations 
to  the  Production  Department  with  reference  to  plant  and  equipment  ex- 
penditures during  the  remainder  of  the  budget  period,  these  recom- 
mendations will  be  communicated  to  the  Works  Manager  through 
the  Assistant  to  the  General  Manager  on  or  before  the  fifteenth  day  of 
the  period. 
25 


386 


BUDGETARY  CONTROL 


4.  Estimate  of  Furniture  and  Fixtures  Required  by  General 

Offices 

On  or  before  the  fifteenth  day  preceding  the  beginning  of  the  budget 
period,  the  head  of  each  department  will  submit  to  the  General  Manager  an 
estimate  of  expenditures  for  Furniture  and  Fixtures  during  the  next  budget 
period.  The  General  Manager  after  consultation  with  the  General  Pur- 
chasing Agent  will  make  such  revisions  as  he  deems  necessary  and  transfer 
the  estimate  with  his  approval  to  the  Assistant  to  the  General  Manager  on 
or  before  the  tenth  day  preceding  the  beginning  of  the  budget  period. 

5.  Approval  by  the  Budget  Committee 

On  or  before  the  first  day  of  the  first  week  preceding  the  begmning  of  the 
budget  period,  the  Assistant  to  the  General  Manager  will  transmit  the  esti- 
mate of  furniture  and  fixtures  as  required  by  the  general  offices  to  the  Budget 
Committee  with  such  recommendations  as  he  may  deem  necessary.  The 
Budget  Committee  will  make  such  changes  as  it  may  deem  expedient  and 
return  the  estimate  with  its  approval  to  the  Assistant  to  the  General  Man- 
ager within  two  days  after  its  receipt  by  the  Committee. 

The  Assistant  to  the  General  Manager  will  return  the  estimate  of  furni- 
ture and  fixtures  to  the  heads  of  the  various  departments  immediately  upon 
its  receipt  by  him  from  the  Budget  Committee. 

6.  Periodic  Report  on  Furniture  and  Fixtures 

On  or  before  the  tenth  day  of  the  period,  the  Assistant  to  the  General 
Manager  will  transmit  a  report  to  the  Budget  Committee  showing  a  com- 
parison between  the  estimated  expenditures  for  furnitures  and  fixtures  for 
the  general  offices  for  the  past  period  and  the  actual  expenditures  as  sub- 
mitted by  the  Accounting  Department.  If  the  Budget  Committee  desires 
to  make  any  recommendations  to  the  departmental  heads  with  reference  to 
furniture  and  fixture  costs  for  the  general  offices  for  the  remainder  of  the 
budget  period,  these  recommendations  will  be  communicated  to  the  de- 
partmental heads  through  the  Assistant  to  the  General  Manager. 

VIII.   The  Expense  Budgets 

I.   Control  of  Departmental  Expense 

In  order  to  provide  an  effective  control  of  the  expenses  of  the  various 
departments,  as  well  as  to  provide  the  necessary  data  for  the  quarterly 
cash  budget,  the  following  procedure  is  prescribed  for  all  departments  and 
executive  units  of  the  business: 


MANUAL  OF  BUDGETARY  PROCEDURE  387 


(1)  Before  the  beginning  of  each  budget  period,  an  estimate  will  be 

prepared  by  the  executi\  e  head  of  each  department  or  unit 
showing  the  anticipated  expenses  of  this  department  or  unit 
for  the  next  budget  period,  and  sent  to  the  Assistant  to  the 
General  Manager. 

(2)  These  estimates  will  be  submitted  by  the  Assistant  to  the  Gen- 

eral Manager  to  the  Budget  Committee  and  after  being  re- 
vised by  it  where  deemed  necessary,  an  appropriation  will  be 
made  to  meet  the  expenses  called  for  by  each  estimate. 

(3)  The  amount  of  the  appropriations,  as  determined  by  the  Budget 

Committee,  will  be  communicated  to  the  executive  respon- 
sible for  the  original  estimate  by  the  Assistant  to  the  General 
Manager. 

(4)  A  monthly  report  will  be  made  to  the  Budget  Committee 

through  the  Assistant  to  the  General  Manager,  showing  the 
status  of  each  of  these  appropriations. 

(5)  The  original  appropriation  will  not  be  exceeded  without  per- 

mission of  the  Budget  Committee. 

2.   Classification  of  Departments  and  Units 

For  the  purpose  of  expense  control  the  various  departments  and  units 
may  be  classified  as  follows: 

A.  Administration 

(1)  General  Manager's  Ofifice 

(2)  Credit  Department 

(3)  Purchasing  Department 

(4)  Accounting  Department 

(5)  Statistical  Department 

(6)  Stenographic  Department 

(7)  Personnel  Department 

B.  Selling 

(1)  General  Ofifice 

(a)  Office  of  the  Sales  Manager 

(b)  Advertising  and  Sales  Promotion 

(2)  Direct  Sales  Units 

(a)  Each  Sales  Office 

C.  Production 

(1)  Ofifice  of  the  Works  Manager 

(2)  Subsidiary  Production  Departments 


388 


BUDGETARY  CONTROL 


3.    Procedure  for  the  Preparation  of  Expense  Budgets 

The  procedure  to  be  followed  in  the  preparation  and  control  of  the  ex- 
pense budgets  of  the  various  departments  and  executive  units  given  in  the 
foregoing  outline  vvill  be  as  follows: 

Group  A.  Administration 

(1)  Preparation  of  Estimate 

On  or  before  the  fifteenth  day  preceding  the  beginning  of  the  budget 
period,  the  executive  head  of  each  of  the  departments  listed  under 
Group  A  will  submit  to  the  Assistant  to  the  General  Manager  an 
estimate  of  the  expenses  of  this  department  during  the  next  budget 
period.  The  form  to  be  used  in  the  submission  of  the  estimates  will 
be  provided  by  the  Assistant  to  the  General  Manager  and  will  con- 
tain the  following  columnar  headings: 

(1)  Department 

(2)  Same  period  last  year 

(3)  Average  for  last  four  budget  periods  preceding  the  one  dur- 

ing which  the  budget  is  prepared 

(4)  Estimated  cost  for  this  period 

(5)  Distribution: 

(a)  First  period 

(b)  Second  period 

(c)  Third  period 

Columns  (2)  and  (3)  will  be  filled  in  by  the  Assistant  to  the  General 
Manager  prior  to  sending  the  form  to  the  executive  head  of  each 
department. 

(2)  Approval  by  the  Budget  Committee 

On  or  before  the  first  day  of  the  first  week  preceding  the  beginning  of 
the  budget  period,  the  Assistant  to  the  General  Manager  will  submit 
the  estimate  of  the  expenses  of  the  departments  listed  in  Group  A 
as  prepared  by  the  executive  heads  of  the  departments,  to  the  B  udge t 
Committee  with  such  recommendations  as  he  may  deem  necessary. 
The  Budget  Committee  will  make  such  changes  as  it  may  deem 
necessary,  and  return  the  estimate  with  its  approval  to  the  Assistant 
to  the  General  Manager  within  two  days  after  the  receipt  of  the 
estimate  by  the  Committee. 


MANUAL  OF  BUDGETARY  PROCEDURE  389 


The  Assistant  to  the  General  Manager  will  return  immediately  the 
estimates  as  approved  by  the  Budget  Committee  to  the  executive 
heads  of  departments  listed  under  Group  A. 

(3)  Periodic  Report 

On  or  before  the  eighth  day  of  each  period  the  Accounting  Department 
will  send  to  the  Assistant  to  the  General  Manager  a  report  showing 
the  expenses  for  the  past  period  for  each  of  the  departments  listed 
under  Group  A.  The  Assistant  to  the  General  Manager  will  supply 
the  form  for  the  submission  of  this  report. 

On  or  before  the  tenth  day  of  the  month,  the  Assistant  to  the  General 
Manager  will  transmit  a  report  to  the  Budget  Committee  showing 
the  comparison  between  estimated  expenses  for  each  of  the  depart- 
ments under  Group  A  for  the  past  period  and  the  actual  expenses  as 
submitted  by  the  accounting  department.  If  the  Budget  Com- 
mittee desires  to  make  any  recommendations  to  the  executive  heads 
of  the  departments  with  reference  to  their  expenses  during  the  re- 
mainder of  the  budget  period,  these  recommendations  will  be  com- 
municated to  the  executive  heads  through  the  Assistant  to  the 
General  Manager. 

Group  B.  Sales 

(1)  Preparation  of  Estimates 

On  or  before  the  tenth  day  preceding  the  beginning  of  the  budget  period, 
the  Sales  Manager  will  transmit  to  the  Assistant  to  the  General 
Manager  an  estimate  of  the  expenses  of  his  department  including: 

(a)  The  expenses  of  himself  and  staff 

(b)  The  expenses  of  the  direct  selling  units 

(c)  The  expenses  of  the  advertising  and  sales  promotion  depart- 

ment 

This  estimate  will  be  submitted  on  a  form  provided  by  the  Assistant  to 
the  General  Manager. 

(2)  Approval  by  the  Budget  Committee 

On  or  before  the  first  day  of  the  first  week  preceding  the  beginning  of 
the  budget  period,  the  Assistant  to  the  General  Manager  will  sub- 
mit the  estimate  of  the  expenses  of  the  departments  listed  under 
Group  B  as  prepared  by  the  Sales  Manager,  to  the  Budget  Com- 
mittee with  such  recommendations  as  he  may  deem  necessar>\  The 


390 


BUDGETARY  CONTROL 


Budget  Committee  will  make  such  changes  as  it  may  deem  neces- 
sary and  return  the  estimate  with  its  approval  to  the  Assistant  to  the 
General  Manager  within  two  days  after  the  receipt  of  the  estimate 
by  the  Committee. 
The  Assistant  to  the  General  Manager  will  return  immediately  the  esti- 
mates as  approved  by  the  Budget  Committee,  to  the  Sales  Manager. 

(3)  Periodic  Report 

On  or  before  the  eighth  day  of  each  period  the  Accounting  Department 
will  send  to  the  Assistant  to  the  General  Manager  a  report  showing 
the  expenses  for  the  past  period  for  each  of  the  divisions  of  the  de- 
partment listed  under  Group  B.  The  Assistant  to  the  General 
Manager  will  supply  the  form  for  the  submission  of  this  report. 

On  or  before  the  tenth  day  of  the  period  the  Assistant  to  the  General 
Manager  will  transmit  a  report  to  the  Budget  Committee  showing 
the  comparison  between  estimated  expenses  for  each  of  the  depart- 
ments under  Group  B  for  the  past  period  and  the  actual  expenses  as 
submitted  by  the  Accounting  Department.  If  the  Budget  Com- 
mittee desires  to  make  any  recommendations  to  the  Sales  Manager 
with  reference  to  the  expenses  of  his  department  during  the  re- 
mainder of  the  budget  period,  these  recommendations  will  be  com- 
municated to  the  Sales  Manager  through  the  Assistant  to  the  Gen- 
eral Manager. 

Group  C.  Production 

(1)  Preparation  of  Estimate 

On  or  before  the  tenth  day  preceding  the  beginningof  the  budget  period, 
the  Works  Manager  will  submit  to  the  Assistant  to  the  General 
Manager  an  estimate  of  the  expenses  of  his  department.  The  ex- 
penses shown  on  this  estimate  will  be  exclusive  of  the  expenses  shown 
on  the  estimate  of  manufacturing  expenses  prepared  as  directed 
under  Section  V.  This  estimate  will  be  submitted  on  a  form  pro- 
vided by  the  Assistant  to  the  General  Manager. 

(2)  Approval  by  the  Budget  Committee 

On  or  before  the  first  day  of  the  week  preceding  the  beginning  of  the 
budget  period,  the  Assistant  to  the  General  Manager  will  submit 
the  estimate  of  the  expenses  of  the  Production  Department  as  pre- 
pared by  the  Works  Manager,  to  the  Budget  Committee  with  such 
recommendations  as  he  may  deem  necessary.    The  Budget  Com- 


MANUAL  OF  BUDGETARY  PROCEDURE 


391 


mittee  will  make  such  changes  as  it  may  deem  necessary  and  return 
the  estimate  with  its  approval  to  the  Assistant  to  the  General  Man- 
ager within  two  da}  s  after  the  receipt  of  the  estimate  by  the  Com- 
mittee. 

The  Assistant  to  the  General  Manager  will  return  immediately  the  esti- 
mate as  approved  by  the  Budget  Committee  to  the  Works  Manager. 

(3)  Periodic  Report 

On  or  before  the  eighth  day  of  each  period,  the  Accounting  Department 
will  send  to  the  Assistant  to  the  General  Manager  a  report  showing 
the  expenses  for  the  past  period  of  the  Production  Department.  The 
Assistant  to  the  General  Manager  will  supply  the  form  for  the  sub- 
mission of  this  report. 

On  or  before  the  tenth  day  of  the  month,  the  Assistant  to  the  General 
Manager  will  transmit  a  report  to  the  Budget  Committee  showing 
the  comparison  between  estimated  expense  for  the  Production  De- 
partment for  the  past  period  and  the  actual  expenses  as  submitted 
by  the  Accounting  Department.  If  the  Budget  Committee  desires 
to  make  any  recommendations  to  the  Works  Manager  with  refer- 
ence to  the  expenses  of  his  department  during  the  remainder  of  the 
budget  period,  these  recommendations  will  be  communicated  to 
the  Works  Manager  through  the  Assistant  to  the  General  Manager. 

IX.  The  Financial  Budget 

I.  Preliminary  Estimates  of  Cash  Receipts  and  Cash  Disburse- 
ments 

The  Assistant  to  the  General  Manager,  working  in  conjunction  with 
the  Assistant  Treasurer,  will  prepare  a  preliminary  estimate  of  cash  receipts 
and  a  preliminary  estimate  of  cash  disbursements  for  each  budget  period 
based  on  the  following: 

(1)  The  estimates  submitted  by  the  various  departments. 

(2)  An  estimate  of  the  disbursements  for  taxes,  insurance,  and 

other  items  which  are  under  the  control  of  the  Assistant 
Treasurer. 

(3)  Estimate  of  the  collections  from  accounts  receivable  outstand- 

ing at  the  beginning  of  the  period. 

(4)  Estimate  of  the  disbursements  on  accounts  payable  outstanding 

at  the  beginning  of  the  period. 


392 


BUDGETARY  CONTROL 


The  Assistant  to  the  General  Manager  will  transmit  these  preliminary 
estimates  of  cash  receipts  and  cash  disbursements  to  the  Budget  Committee 
on  or  before  the  first  day  of  the  first  week  preceding  the  beginning  of  the 
budget  period.  This  will  enable  the  Budget  Committee  to  consider  the 
financial  requirements  of  the  various  estimates  submitted  to  it. 

2.  Revision  of  Preliminary  Estimates 

After  the  departmental  estimates  have  been  approved  by  the  Budget 
Committee,  the  Assistant  to  the  General  Manager  will  revise  the  prelimi- 
nary estimates  of  cash  receipts  and  cash  disbursements  giving  effect  to  the 
revisions  in  the  departmental  estimate  which  were  made  by  the  Budget 
Committee.  The  revised  estimates  will  be  submitted  to  the  Treasurer  on 
or  before  the  third  day  preceding  the  beginning  of  the  budget  period. 

3.  Periodic  Reports 

Periodic  reports  will  be  submitted  to  the  Budget  Committee  showing  a 
comparison  between  estimated  receipts  and  actual  receipts  and  estimated 
disbursements  and  actual  disbursements.  If  the  Budget  Committee  desires 
to  revise  other  budgets  because  of  the  financial  condition,  these  revisions 
will  be  submitted  to  the  departments  concerned  by  the  Assistant  to  the 
General  Manager.  The  revisions  made  in  the  financial  budget  will  be 
communicated  to  the  Treasurer. 

X.  Preliminary  Estimated  Financial  Statements 

1.  Preliminary  Estimates  of  Financial  Condition  and  Results  of 

Operation 

The  Assistant  to  the  General  Manager  will  prepare  from  the  departmen- 
tal budgets  an  estimated  balance  sheet  showing  the  estimated  financial 
condition  at  the  end  of  each  accounting  period  during  the  budget  period. 
He  will  also  prepare  in  the  same  manner  an  estimated  statement  of  profit 
and  loss  showing  the  anticipated  results  of  the  operations  for  each  period. 

The  Assistant  to  the  General  Manager  will  transmit  these  preliminary 
estimates  to  the  Budget  Committee  on  or  before  the  first  day  of  the  first 
week  preceding  the  beginning  of  the  budget  period.  This  will  enable  the 
Budget  Committee  to  consider  these  at  the  same  time  that  it  is  considering 
the  departmental  estimates. 

2.  Revision  of  Preliminary  Estimates 

After  the  departmental  estimates  have  been  approved  by  the  Budget 
Committee,  the  Assistant  to  the  General  Manager  will  revise  the  prelimi- 


MANUAL  OF  BUDGETARY  PROCEDURE 


393 


nary  estimated  financial  statements  giving  effect  to  the  changes  made  by  the 
committee  in  the  departmental  estimates. 

3.    Periodic  Reports 

Periodic  reports  will  be  submitted  to  the  Budget  Committee  by  the 
Assistant  to  the  General  Manager,  showing  a  comparison  between  the 
actual  and  the  estimated  financial  statements.  These  reports  will  be  sub- 
mitted at  the  same  time  as  the  other  budgetary'  reports. 

Comments  on  Manual — Manual  Confined  to  Interdepartmental 
Procedure 

It  will  be  noticed  that  the  manual  is  confined  to  the  pro- 
cedure involved  in  the  interdepartmental  relations  arising 
from  the  budgetary  program.  It  does  not  outline  in  detail 
the  procedure  to  be  followed  by  each  department  in  the 
preparation  of  its  estimate  or  the  carrying  out  of  its 
budget.  Since  the  manual  is  to  be  placed  in  the  hands 
of  all  of  the  executives,  it  is  not  thought  worth  while  to 
encumber  it  with  the  detail  of  departmental  procedures. 
It  is  thought  better  that  these  be  issued  as  departmental 
orders. 

Central  Control  of  Estimates 

It  is  important  to  notice  that  the  manual  requires  the 
estimates  of  all  departments  to  be  submitted  to  the  budget 
committee  at  one  time  (on  or  before  the  first  day  of  the  first 
week  preceding  the  beginning  of  the  budget  period) ;  the 
consideration  and  approval  of  these  estimates  within  two 
days  after  their  receipt;  and  the  return  of  the  approved  esti- 
mates to  the  departmental  heads  immediately  upon  their 
approval. 

This  enables  the  budget  committee  to  have  before  it,  at 
one  time,  the  estimates  of  all  the  departments  and  units  of 
the  company,  and  provides  a  central  control  of  all  the  ac- 
tivities of  the  business.    The  monthly  reports  which  are  to 


394 


BUDGETARY  CONTROL 


be  submitted  to  the  budget  committee  provide  a  means  of 
control  over  the  execution  of  the  budgets. 

Authority  of  Budget  Committee 

It  will  be  noted  that  the  budget  committee  is  given  au- 
thority to  pass  on  estimates.  Although  the  manual  does 
not  so  state,  the  financial  budget  and  the  estimated  balance 
sheet  and  statement  of  profit  and  loss  are  submitted  to  the 
board  of  directors  at  the  beginning  of  each  budget  period. 

Dates  for  Submission  of  Estimates  and  Reports 

It  will  be  noticed  that  particular  attention  is  given  to  the 
dates  on  which  reports  and  estimates  are  submitted.  This 
is  especially  important,  as  otherwise  there  will  be  a  lack  of 
coordination  in  the  budgetary  procedure.  For  instance,  the 
production  department  cannot  prepare  the  finished  goods 
estimate  until  it  receives  the  sales  estimate ;  the  purchasing 
department  cannot  prepare  the  estimate  of  purchases  until 
it  receives  the  estimate  of  materials  requirements ;  and  the 
assistant  to  the  general  manager  cannot  prepare  the 
estimated  financial  statements  until  he  receives  all  the  esti- 
mates. These  illustrations  show  that  if  one  department  is 
tardy  in  the  preparation  of  its  estimate  or  report,  the  entire 
program  is  delayed  as  a  consequence. 

Chart  of  Budget  Procedure 

A  manual  prepared  in  the  form  of  the  foregoing  example 
contains  a  considerable  amount  of  detail  and  it  is  some- 
what difficult  to  obtain  a  comprehensive  view  of  the  pro- 
cedure as  a  whole. 

A  chart  prepared  in  the  form  shown  in  Figure  43,  enables 
the  executives  to  see  the  relationship  between  the  various 
budgets  and  the  duties  of  each  executive  with  reference  to 
each  budget. 


F. 

ST. 

G. 

AC 

H.  PU 


SALES 
BUDGET 

PRODUCTION 
BUDGET 

PAY-ROLL 
BUDGET 

— 1   IMmtu.  or  mo  ».lo 

STORES  PURCHASE 
BUDGET 

MATERIAL 
BUDGET 

PLANT  AND  EQUIP- 
MENT BUDGET 

MISCELLANEOUS 
EXPENSE  BirDGET 

FINANCIAL 
BUDGET 

XsALES  MANAGER 

1.  AnUdpaUJ  ulu  for  budgui 
period,  by  Krado^and  •'J^'J^J^'g^ 

""a  "nocrtve  rovlwd  saltu  BudKot 
from  E  on  or  bcforo  itjUi  day  anM- 
clooo  of  period. 

jSSr^S-rSl^lfty 

■  ' 

KoulpowiiV 'liui(f^rrLm''E'o.i''."T' 
b^'iv  IMti  da>-  artitr  cloM-  .  i 

B.  WORKS  MANAGER 



 -  

C.  GENERAL  MANAGER 

D.  BUDGET  COMMITTEE 

' : 'lor-'rVrprrKoT'S^ 

nrwjT  cloHC  or  period. 

liSSHIs'FsFo'FbS'E 

12Ui  aay  ittcr  clo«>  or  period. 

Ssbcm:.  iVm„":„"„,,;;;„;.h 

d»y  nrwr  di,.e  or  i.iilod. 

li;.'.  ,;:":„", '-"!"'"»««" 

or^l^fo™  I2tl,  day  i>l?«r  closo  of 

BE'".;:! 

Srii"' 

E.  ASSISTANT    TO  THE 

'  ;,?;"-;■■;;„;-!!, 

ai-s-d^y-w.fisv 

F.  STATISTICAL  DEPT. 



0.  ACCOUNTING  DEPT. 

H.  PURCHASING  AGENT 

FIGURE  43-    CHART  OF  BUDGET  PROCEDURE 


MANUAL  OF  BUDGETARY  PROCEDURE  395 


The  chart  is  prepared  from  the  manual  given  in  this 
chapter  with  a  few  modifications.  It  will  be  noticed  that 
the  chart  calls  for  a  "stores  purchased  "  budget  and  a  "  mis- 
cellaneous expense"  budget,  instead  of  a  manufacturing  ex- 
pense budget  and  departmental  expense  budgets.  It  also 
omits  the  procedure  for  the  preparation  of  the  estimated 
financial  statements. 


CHAPTER  XXIV 


ADMINISTRATIVE  REPORTS 

Need  for  Administrative  Reports 

The  previous  chapters  have  emphasized  the  need  for  the 
collection  of  data  to  serve 

1.  As  the  basis  of  formulating  plans  of  operation,  and 

2.  As  the  basis  of  enforcing  plans  which  have  been  adopted. 

This  information  is  most  serviceable  when  it  is  presented  in 
a  summarized  and  classified  form  by  means  of  properly  de- 
signed reports. 

Reports  should  be  used  by  all  the  executives  and  em- 
ployees of  a  business.  We  usually  think  of  reports  in  con- 
nection with  the  general  officers,  for  their  actions  are  based 
largely  on  reports  and  the  reports  which  they  receive  are  of  a 
formal  nature.  Nevertheless,  all  employees  except  those 
engaged  in  routine  manual  tasks  are  receiving  reports  daily. 
These  reports  may  come  to  them  as  business  forms  on  which 
they  perform  certain  tasks  and  then  transmit  them  to  others. 
They  are  nevertheless  reports  in  the  sense  in  which  that 
term  is  used  in  this  discussion. 

Classification  of  Administrative  Reports 

The  reports  used  in  administrative  control  may  be  clas- 
sified broadly  into  the  following  groups: 

I.  Reports  showing  present  financial  condition.  The  standard 
form  of  balance  sheet  with  its  various  subsidiary  schedules 
is  used  for  this  purpose.  This  is  the  oldest  and  most  widely 
used  of  administrative  reports.  The  reasons  for  its  origin 
and  extensive  use  have  been  explained  in  a  preceding  chapter. 
396 


ADMINISTRATIVE  REPORTS 


397 


2.  Reports  showing  the  results  of  past  operations  in  terms  of  ex- 

pense and  income.  The  various  forms  of  expense  and  income 
analyses,  and  the  standard  form  of  statement  of  profit  and 
loss,  with  subsidiary  schedules,  are  used  for  this  purpose.  Next 
to  the  standard  form  of  balance  sheet,  these  are  the  reports 
most  widely  used.  For  internal  control  they  are  used  more 
widely  than  the  balance  sheet  and  are  decidedly  more 
serviceable. 

3.  Reports  showing  pertinent  information  which  is  necessary  for  the 

daily  actions  of  executives  and  employees.  These  reports  may 
consist  of  a  statement  for  the  treasurer,  showing  the  accounts 
payable  falling  due  on  a  current  day;  of  a  report  to  the  collec- 
tion manager,  showing  accounts  thirty,  sixty,  and  ninety  days 
past  due;  of  a  report  to  the  sales  manager,  showing  the  slow- 
moving  items  of  stock;  and  various  other  reports  of  a  similar 
nature.  These  reports  are  not  so  widely  discussed  as  the 
standard  financial  statements,  yet  they  serve  a  very  vital 
function  in  the  internal  administration  of  a  business. 

4.  Reports  showing  anticipated  results  of  future  operations.  These 

reports  include  estimates  of  sales,  estimates  of  purchases, 
estimates  of  production,  estimates  of  financial  condition,  esti- 
mates of  income,  expense,  and  net  profit,  and  similar  reports. 
These  estimates  serve  as  a  basis  for  future  plans  in  the  manner 
explained  in  preceding  chapters. 

5.  Reports  shoVing  a  comparison  between  the  actual  performance 

and  the  estimated  or  standard  performance.  Such  reports 
make  possible  the  enforcement  of  budgets  and  provide  data 
which  serve  as  a  means  of  revising  the  budgets  when  this  is 
found  necessary. 

Essentials  of  Executive  Reports 

In  the  foregoing  discussion  administrative  reports  have 
been  defined  broadly  to  include  the  reports  used  by  all  the 
executives  and  employees  of  a  business.  But  in  every  busi- 
ness it  is  desirable  to  prepare  some  formal  reports  for  the 
use  of  the  principal  executives  only.  In  contradistinction 
to  the  broad  group  of  administrative  reports,  these  may  be 
termed  "executive"  reports.    During  the  remainder  of  this 


398 


BUDGETARY  CONTROL 


chapter  we  shall  be  concerned  primarily  with  the  latter 
group,  although  most  of  the  discussion  is  equally  applicable 
to  the  general  group. 

Since  executive  reports  are  intended  to  serve  as  a  basis 
for  the  formulating  of  executive  decisions,  which  in  turn 
result  in  executive  actions,  it  is  expedient  that  they  be  made 
so  as  to  present  accurate  and  comprehensive  information 
and  to  present  it  in  such  form  that  correct  judgments  can 
be  formed  with  as  little  sacrifice  of  effort  as  possible.  If  this 
end  is  to  be  attained,  executive  reports  must  have  the  fol- 
lowing characteristics : 

First,  they  should  present  summarized  information. 
Details  should  be  eliminated  as  much  as  possible.  Each 
report  should  show  a  few  essential  items  of  information. 
They  should  be  constructed  so  as  to  show  variations  between 
the  standard  performance  and  the  actual  performance.  In 
case  of  significant  variations,  the  executive  should  receive  an 
explanation  of  the  cause  from  the  controller  or  some  other 
official  designated  for  this  purpose.  If  the  executive  re- 
ceives a  few  condensed  reports  he  will  be  able  to  study  care- 
fully each  report.  Details  are  of  value  only  to  explain 
variations.    Many  details  serve  only  to  confuse. 

Second,  executive  reports  should  show  the  following: 

1.  Actual  performance  for  the  current  period. 

2.  Comparison  of  the  performance  of  the  current  period  with  the 

estimated  or  standard  performance  for  tlie  period. 

3.  Comparison  of  the  current  performance  with  the  performance  of 

past  periods. 

4.  Comparison  of  the  current  performance  with  the  results  of  the 

performance. 

Actual  Performance 

Each  executive  should  know  at  frequent  intervals  what 
the  performance  has  been  of  his  own  department  and  of  each 
of  the  other  departments  the  activities  of  which  affect  the 


/ 


ADMINISTRATIVE  REPORTS  399 

activities  of  his  own  department.  Reports  presenting  in- 
formation of  this  kind  have  long  been  in  use  and  httle  more 
need  be  said  here  with  reference  to  them  than  to  emphasize 
the  following: 

1 .  That  care  must  be  taken  that  these  reports  be  made  accurately. 

2.  That  they  be  sufficiently  comprehensive  to  serve  as  a  basis  for 

proper  action. 

3.  That  they  should  be  made  promptly. 

4.  That  they  are  more  effective  if  modified  so  as  to  include  the 

comparisons  indicated  by  the  following  discussion. 

Estimated  Performance 

Most  if  not  all  executives  will  admit  the  need  of  a  state- 
ment of  the  current  performance,  but  many  do  not  realize 
the  importance  of  establishing  estimates  of  performance 
and  comparing  the  actual  with  the  estimated.  The  dis- 
cussion in  the  preceding  chapters  has  emphasized  the  im- 
portance of  preparing  budgets  and  using  them  as  control 
devices.  The  reports  which  are  used  in  preparing  and  con- 
trolling these  budgets  have  been  discussed  in  connection 
with  each  of  them.  In  addition  to  these  reports  it  is  de- 
sirable that  the  effect  of  the  budgetary  program  should 
be  shoM'n  on  all  the  executive  reports.  This  can  be  done 
most  easily  ty  designing  these  reports  so  that  they  will  show 
a  comparison  between  the  estimated  and  the  actual  per- 
formance. 

By  way  of  emphasis  it  is  worth  while  to  state  the  follow- 
ing benefits  to  be  derived  from  the  establishment  of  the 
estimates : 

1 .  In  order  to  make  the  estimates  it  will  be  necessary  for 
the  executives  responsible  for  them  to  study  past  perform- 
ance and  to  consider  future  possibilities.  This  study  will 
undoubtedly  increase  the  efficiency  of  these  executives. 

2.  The  estimates  will  set  up  a  goal  for  attainment.  They 
will  constitute  a  "bogie"  which  the  executives  will  try  to 


400 


BUDGETARY  CONTROL 


attain.  A  comparison  between  the  actual  and  the  estimated 
will  provide  a  check  on  the  activities  of  the  executives  and 
will  serv^e  as  an  incentive  towards  the  attainment  of  the 
estimated. 

3.  A  study  and  comparison  of  the  estimates  will  make 
possible  a  better  coordination  of  the  activities  of  the  various 
functional  departments,  since  each  department  can  deter- 
mine from  the  estimates  the  plans  of  other  departments  and 
guide  its  activities  accordingly. 

4.  The  preparation  and  use  of  the  estimates  will  make 
possible  the  elimination  of  much  detail  in  the  reports  to  the 
executives.  Details  instead  of  being  presented  for  the  con- 
sideration of  the  executives  each  month,  will  be  presented 
in  the  original  estimates  when  they  are  presented  for  execu- 
tive approval.  After  the  estimates  have  been  considered 
and  approved,  it  will  not  be  necessary  for  the  executive  to 
receive  detailed  reports  during  the  period  covered  by  the 
estimates.  If  he  receives  a  summary  report  which  shows  a 
comparison  between  the  results  attained  and  the  estimate, 
it  will  be  sufficient.  Executives  should  consider  details  with 
reference  to  operations  before  the  operations  take  place  rather 
than  after  they  are  performed.  Of  course,  if  variations  be- 
tween the  estimated  and  the  actual  are  shown  by  the  reports, 
they  may  ask  for  sufficient  detail  to  explain  the  changes. 

Past  Performance 

Although  past  performance  alone  is  not  a  satisfactory 
standard  by  which  to  judge  current  performance,  a  com- 
parison between  current  performance  and  past  performance 
is  very  useful  in  that  it  shows  whether  the  te?idency  is  desira- 
ble or  undesirable.  If  statistics  with  reference  to  past  per- 
formance and  current  performance  are  compiled  by  means 
of  reports  for  a  considerable  number  of  periods,  very  useful 
data  will  be  available  for  use  in  making  future  estimates. 


ADMINISTRATIVE  REPORTS 


401 


Results  of  Performance 

Whenever  possible,  a  comparison  should  be  made  be- 
tween performance  and  results.  For  instance,  selling  ex- 
pense may  be  compared  with  sales;  gross  profits  and  net 
profits  with  sales;  volume  of  production  with  cost  of  pro- 
duction; and  various  other  comparisons  which  will  occur  to 
the  reader.  These  comparisons  should  be  shown  not  only 
for  the  current  period  but  also  for  past  periods,  so  that 
tendencies  may  be  easily  seen.  Comparisons  of  this  nature 
make  it  possible  to  obtain  a  true  perspective  of  results. 
Obviously  increased  sales  are  desired  only  when  increased 
profits  will  result. 

Illustration  of  Reports 

It  is  obviously  impossible  to  discuss  and  illustrate  all 
the  various  reports  which  may  be  used  in  executive  control. 
These  will  vary  in  number  and  form  from  business  to  busi- 
ness. 

Some  of  these  reports  have  been  illustrated  in  previous 
chapters.  For  instance,  in  Chapters  XXI  and  XXII  the 
estimated  balance  sheet  and  estimated  statement  of  profit 
and  loss  with  the  proper  comparisons  were  illustrated.  In 
earlier  chapters  reports  showing  a  comparison  between  the 
actual  and  estimated  performance  were  shown. 

In  the  present  discussion  it  is  thought  sufficient  to  illus- 
trate a  few  of  the  reports  which  may  be  used  in  sales  and 
production  control.  Using  these  as  types  and  applying 
the  general  principles  given  in  the  foregoing  discussion,  the 
reader  should  be  able  to  design  reports  to  fit  any  particular 
needs. 

Sales  Reports 

The  reports  which  may  be  used  in  sales  control  are  too 
numerous  to  mention.    They  will  vary  greatly  from  busi- 

26 


402 


BUDGETARY  CONTROL 


ADMINISTRATIVE  REPORTS 


404 


BUDGETARY  CONTROL 


ness  to  business  depending  on  the  volume  of  sales,  nature  of 
product  sold,  and  method  of  marketing.  But  it  is  thought 
that  in  every  business  the  principal  executives  of  the  busi- 
ness should  have  reports  which  show  the  following: 

1.  Volume  of  sales 

2.  Selling  expenses 

3.  Net  profits 

4.  Inventory  of  finished  goods 

Typical  reports  for  each  of  these  will  be  illustrated. 

Monthly  Report  on  Volume  of  Sales 

If  a  business  markets  its  product  through  branches  or 
divisions,  this  report  will  show  the  total  sales  of  each  selling 
unit  for  the  current  period  compared  with  the  estimated 
sales  and  the  sales  of  previous  periods.  If  the  sales  are  all 
made  from  a  central  office,  it  may  show  the  same  compari- 
sons for  sales  territories,  or  it  may  show  the  sales  classified 
by  groups,  departments,  or  products.  In  any  case  the  com- 
parisons should  be  the  same. 

A  typical  form  for  this  report  is  shown  in  Figure  44. 
This  report  is  designed  for  the  use  of  a  manufacturing  com- 
pany marketing  its  product  partly  through  division  sales 
offices  and  partly  through  sales  branches.  This  report 
shows  useful  comparisons  for  each  selling  unit  and  in  addi- 
tion provides  a  means  of  comparing  the  results  attained  by 
the  different  units. 

Monthly  Report  on  Selling  Expenses 

If  a  business  markets  its  product  through  divisions  or 
branches,  a  monthly  report  should  be  made  to  show  the 
total  selling  expense  of  each  selling  unit  with  a  comparison 
of  this  expense  with  the  sales  obtained.  If  the  sales  are 
made  from  a  central  sales  department,  this  report  may  show 
the  same  comparisons  by  territories.    If  selling  expenses 


ADMINISTRATIVE  REPORTS 


4^5 


4o6 


BUDGETARY  CONTROL 


are  allocated  to  lines  of  product,  the  report  may  be  made  to 
show  the  result  of  this  allocation.  In  a  department  store  it 
may  show  sales  and  expenses  by  departments.  In  this 
latter  case  judgment  must  be  used  in  interpreting  the  re- 
port, for  it  is  to  be  expected  that  the  ratio  of  expense  to  sales 
will  vary  between  departments  which  sell  different  kinds 
of  goods. 

A  typical  form  for  this  report  is  shown  in  Figure  45. 
The  report  provides  a  means  of: 

1.  Checking  actual  expenses  against  estimated  expenses. 

2.  Comparing  the  ratio  of  expenses  to  sales  during  the  current  and 

past  periods.  This  comparison  is  of  especial  importance,  as 
increases  and  decreases  in  selling  expenses  are  of  significance 
only  in  comparison  with  the  results  obtained. 

3.  Comparing  the  ratio  of  expenses  to  sales  in  different  selling  units. 

This  comparison  is  significant  in  judging  the  efficiency  of 
branch  executives. 

Monthly  Report  on  Net  Profits 

This  report  may  show  net  profits  of  selling  units,  terri- 
tories, departments,  or  by  lines  of  goods.  In  a  business 
marketing  its  product  through  branches  or  division  offices, 
it  shows  the  net  profits  made  by  each  selling  unit  and 
the  ratio  of  net  profits  to  sales  with  the  proper  com- 
parisons. 

A  typical  form  for  this  report  is  shown  in  Figure  46. 
This  report  affords  a  means  of: 

1 .  Checking  actual  net  profits  against  estimated  net  profits. 

2.  Comparing  the  ratio  of  net  profits  to  sales  during  the  current 

year  with  the  same  ratio  for  the  past  year.  This  comparison 
is  a  very  important  one,  since  it  is  not  an  increase  of  sales,  but 
an  increase  of  profits  that  is  the  goal. 

3.  Comparing  the  ratio  of  profits  to  sales  in  diff'erent  selling  units. 

This  comparison  is  important  in  judging  the  efficiency  of 
the  management  of  the  various  units. 


ADMINISTRATIVE  REPORTS 


407 


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BUDGETARY  CONTROL 


ADMINISTRATIVE  REPORTS 


BUDGETARY  CONTROL 


Monthly  Stock  Report 

This  report  should  show  the  total  inventory  in  stock 
classified  according  to  the  major  groups  maintained  for 
sales  and  inventory.  It  should  show  the  comparisons  indi- 
cated by  form  in  Figure  47. 

It  is  desirable  that  a  standard  or  estimated  inventory  be 
determined  which  can  be  used  as  a  means  of  judging  the  size 
of  the  inventory  on  hand.  It  is  important  that  careful 
consideration  be  given  to  turnover  figures;  so  it  is  well  to 
have  them  shown  on  the  periodical  reports.  If  the  turn- 
over for  each  quarter  is  shown  this  should  be  sufficient. 

Production  Reports 

The  reports  which  may  be  used  in  production  control 
are  too  numerous  to  mention.  They  will  vary  greatly  from 
business  to  business,  depending  on  the  volume  of  production, 
the  nature  of  the  production  process,  and  the  organization 
by  which  the  production  is  carried  on.  But  it  is  thought 
that  in  every  business  the  executives  should  have  reports 
which  show  the  following : 

1.  Summary  of  Orders  Received,  Shipments,  Production,  and 

Shortage  or  Surplus 

2.  Summary  of  Operations 

3.  Unit  Costs 

4.  Factory  Inventories 

Monthly  Summary  of  Orders  Received,  Shipments,  Production, 
and  Shortage  or  Surplus 

This  report  shows  the  orders  received,  the  shipments, 
the  production  and  the  unfilled  orders  for  the  current  period 
and  for  past  periods,  in  such  form  that  comparisons  can 
be  easily  made.  Each  of  these  items  will  be  classified 
according  to  the  major  groupings  maintained  for  sales, 
production,  and  inventory.    It  is  preferable  that  it  be 


ADMINISTRATIVE  REPORTS 


411 


made  in  terms  of  physical  units  rather  than  in  terms 
of  value. 

A  typical  form  for  this  report  is  shown  in  Figure  48.  As 
indicated  by  the  illustration,  totals  are  shown  at  the  bot- 
tom of  the  form  so  that  the  totals  of  the  groups  can  be  com- 
pared. If  a  company  has  two  or  more  factories  a  separate 
report  will  be  made  for  each  factory. 

If  desired,  a  separate  report  can  be  prepared  for  each  of 
the  items  which  appear  on  the  combined  report,  that  is, 
orders  received,  shipments,  production,  and  unfilled  orders. 
Each  of  these  reports  should  show  the  following  compari- 
sons: 

1.  Group  (name  or  number) 

2.  This  month 

3.  Estimated  this  month 

4.  Per  cent  of  increase  or  decrease 

5.  Last  month 

6.  Per  cent  of  increase  or  decrease 

7.  Same  month  last  year 

8.  Per  cent  of  increase  or  decrease 

9.  Total  to  date  this  year 

10.  Total  to  date  last  year 

11.  Per  cent  of  increase  or  decrease 

The  additional  information  which  these  subsidiary  reports 
provide  is  evident. 

Monthly  Summary  of  Operations 

It  is  desirable  that  both  the  production  and  other  execu- 
tives of  the  company  should  have  a  comprehensive  picture 
of  the  factory  operations  for  each  period.  A  possible  form 
for  a  report  which  will  provide  this  is  shown  in  Figure  49. 
The  purpose  of  the  data  shown  in  this  report  is  apparent. 

In  some  cases  the  classification  of  cost  elements  shown  in 
the  first  column  will  need  to  be  changed.  It  can  be  made  to 
suit  the  needs  of  each  case. 


412 


BUDGETARY  CONTROL 


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ADMINISTRATIVE  REPORTS 


Monthly  Report  on  Unit  Costs 

This  report  shows  the  volume  of  production  as  well  as 
the  unit  costs.  The  volume  of  production  is  significant  in 
comparing  unit  costs,  since  the  quantity  produced  may- 
affect  the  unit  costs. 

A  typical  form  for  this  report  is  shown  in  Figure  50.  In 
the  illustration  the  volume  of  production  is  stated  in  terms 
of  tons,  and  pounds  are  used  as  the  basis  of  stating  unit  costs. 
In  many  businesses  it  would  be  necessary  to  use  other  units 
for  both  of  these. 

Monthly  Report  on  Factory  Inventories 

This  report  shows  the  total  inventories  carried  at  the 
factory  with  appropriate  comparisons.  The  classification 
of  inventory  will  depend  on  the  nature  of  the  product  manu- 
factured, but  should  always  indicate  clearly  the  inventories 
of  (i)  raw  materials,  (2)  work  in  process,  and  (3)  finished 
goods.  It  should  also  show  plant  and  equipment  in  process 
as  a  separate  item.  It  is  preferable  that  both  the  physical 
amount  and  the  value  of  the  inventories  be  stated. 

A  possible  form  of  this  report  is  shown  in  Figure  51. 

Varied  Kind  of  Reports 

It  is  desired  to  emphasize  once  more  that  the  few  reports 
illustrated  in  this  chapter  are  intended  to  be  suggestive  only. 
These  few  are  given  primarily  for  the  purpose  of  showing 
concretely  the  application  of  the  principles  discussed  in  the 
first  part  of  this  chapter.  The  reports  needed  for  any  par- 
ticular business  can  be  designed  only  after  a  careful  study 
of  its  operations  and  of  its  organization  and  administrative 
methods. 


CHAPTER  XXV 


ADVANTAGES  AND  LIMITATIONS  OF  BUDGET- 
ARY CONTROL 

Advantages  of  Budgetary  Control 

Why  Discussion  Is  Postponed 

In  most  texts  on  accounting,  cost  accounting,  auditing, 
and  similar  subjects,  the  authors  explain  at  the  beginning  of 
their  texts  the  advantages  to  be  derived  from  the  applica- 
tion of  the  methods  which  they  are  to  discuss.  This  un- 
doubtedly is  good  propaganda,  but  it  is  the  author's  impres- 
sion that  the  reader  can  better  understand  the  advantages 
of  any  administrative  procedure  or  device  after  he  under- 
stands its  nature  and  its  method  of  operation.  Conse- 
quently, he  has  deemed  it  expedient  to  postpone  the  discus- 
sion of  the  advantages  of  budgetary  control  until  the  end  of 
the  text.  The  advantages  which  are  thought  to  be  most 
significant  vi^ill  now  be  discussed. 

Coordination  of  Sales  and  Production 

Goods  can  be  sold  only  when  produced,  and  they  should 
be  produced  only  when  they  can  be  sold.  To  obtain  sales 
orders  which  cannot  be  filled  leads  to  loss  in  several  ways,  of 
which  the  following  are  the  most  apparent : 

1 .  It  causes  the  incurrence  of  unnecessary  expenses  in  getting  orders 

which  cannot  be  filled. 

2.  It  causes  the  expense  of  recording  the  orders  when  received. 

3.  It  causes  the  expense  of  answering  the  inevitable  complaints  of 

the  customers  who  fail  to  receive  the  goods  when  promised. 
416 


ADVANTAGES  AND  LIMITATIONS 


'  4.  It  causes  the  expense  of  reversing  the  entries  made  for  the  order 
when  the  customer  finally  cancels  it. 
5.  It  incurs  the  ill-will  of  the  customer,  which  may  result  in  the 
loss  of  his  trade  in  the  future  when  it  may  be  needed. 

On  the  other  hand,  the  production  of  goods  in  excess  of 
sales  orders  leads  to  even  more  undesirable  results,  of  which 
the  following  are  the  most  important: 

1.  It  ties  up  capital  in  unsalable  goods,  with  the  consequent  cost 

incurred  in  securing  the  capital. 

2.  It  ties  up  capital  which  may  be  needed  badly  in  carrying  on  other 

operations,  and  in  some  cases  the  loss  of  the  use  of  this  capital 
may  result  in  serious  financial  embarrassments. 

3.  It  results  in  the  procurement  of  goods  which  may  physically  de- 

teriorate or  become  obsolete  before  they  can  be  sold. 

If  a  sales  estimate  is  prepared,  and  this  estimate  is 
appro\'cd  by  the  production  department  and  used  as  a  basis 
of  its  program,  these  difficulties  can  in  the  main  be  elimi- 
nated. Any  disagreement  between  the  sales  and  production 
departments  is  settled  by  the  budget  committee,  which  is 
qualified  to  render  impartial  judgment. 

What  is  said  here  with  reference  to  the  coordination  of 
sales  and  production  in  a  manufacturing  business,  applies 
equally  to  the  coordination  of  sales  and  purchases  in  a  mer- 
cantile business. 

Formulation  of  a  Profitable  Sales  and  Production  Program 

The  sales  department  does  not  always  desire  to  sell  the 
goods  which  can  be  produced  to  the  best  advantage,  and 
the  production  department  does  not  always  prefer  to  pro- 
duce the  goods  for  which  there  is  the  most  ready  and  prof- 
itable market.  If  left  to  itself  each  department  will  follow 
the  line  of  least  resistance. 

There  has  long  been  an  argument  as  to  whether  the  sales 
or  production  department  should  exercise  the  greater  influ- 

27 


4i8 


BUDGETARY  CONTROL 


ence  in  deciding  the  commodities  which  a  business  produces 
and  offers  for  sale.  Production  executives  often  contend 
that  the  production  department  should  decide  what  it  is  best 
equipped  to  produce  and  that  the  sales  department  should 
then  be  instructed  to  find  a  market  for  these  products.  On 
the  other  hand,  sales  executives  often  contend  that  it  is  the 
function  of  the  production  department  to  serve  the  sales 
department  and  to  produce  the  goods  which  the  latter  can 
sell. 

A  little  consideration  will  show  that  neither  of  these 
views  is  correct.  It  is  the  function  of  each  of  these  depart- 
ments to  serve  the  business  as  a  whole  to  the  end  that  as 
much  profit  as  possible  may  be  made.  The  hundreds  of  idle 
factories  in  the  country  e\cr\  in  normal  times  is  a  testimonial 
to  the  fallacy  of  attempting  to  produce  without  a  proper 
consideration  of  the  market,  and  the  many  discarded  ma- 
chines of  factories  still  operating,  as  well  as  the  hundreds  of 
items  sold  at  a  loss,  is  evidence  of  the  impropriety  of  trying 
to  change  the  production  program  to  meet  the  passing 
whims  of  the  sales  department. 

A  proper  coordination  of  sales  and  production,  not  only 
from  the  viewpoint  of  quantity,  but  also  from  the  viewpoint 
of  profit,  is  essential.  The  production  equipment  should 
be  as  flexible  as  possible  so  that  changes  can  be  made  to 
meet  market  conditions,  but  a  certain  amount  of  standard- 
ization is  essential  to  well-regulated  production,  and  the 
sales  department  by  proper  effort  can  do  much  to  in- 
crease the  sales  of  those  lines  which  can  be  produced  most 
efficiently. 

Although  it  is  usually  convenient  for  the  sales  depart- 
ment to  take  the  first  step  in  the  budgetary  process,  the 
sales  estimate  must  be  gone  over  from  the  viewpoint  of  the 
production  possibilities,  profit  potentialities,  and  financial 
requirements. 


ADVANTAGES  AND  LIMITATIONS 


419 


Coordination  of  Sales  and  Production  Programs  with  Finances 

No  sales  and  production  progrr-m,  regardless  of  its 
profit  potentialities,  is  desirable  if  its  financial  requirements 
cannot  be  met  by  the  particular  firm  under  consideration. 
It  is  necessary^  that  careful  consideration  be  given  to  the 
financial  requirements  of  all  plans  contemplated.  As  stated 
in  Chapter  II,  a  lack  of  coordination  between  sales  and  pro- 
duction will  lead  to  a  loss,  but  a  lack  of  coordination  between 
sales,  production,  and  finance  will  lead  to  bankruptcy. 

It  must  be  remembered,  however,  that  the  capital  pos- 
sibilities of  a  firm  may  be  materially  affected  by  the  length 
of  time  w^hich  is  available  for  planning  to  meet  require- 
ments. If  the  financial  requirements  of  the  contemplated 
program  are  known  for  a  sufficient  length  of  time  prior  to  its 
initiation,  capital  may  be  secured  which  would  not  be  obtain- 
able on  short  notice. 

The  budgetary  program,  therefore,  is  especially  signifi- 
cant in  financial  planning  and  financial  planning  is  the 
essence  of  financial  administration. 

Proper  Control  of  Expenses 

A  proper  control  of  expenses  is  necessary  to  profitable 
operations.  The  purchase  and  sales  prices  of  commodities 
are  usually  determined  largely  by  competition.  The  dif- 
ference between  the  expenses  incurred  and  the  gross  profit 
determines  the  margin  of  net  profit.  To  secure  an  effective 
control  of  expenses  and  yet  not  to  affect  the  volume  of 
profitable  operations  is  one  of  the  most  important  and  diffi- 
cult tasks  of  management. 

If  the  estimated  expenses  of  each  department  are  sub- 
mitted for  the  consideration  of  a  central  budget  committee, 
composed  of  the  principal  executives  of  the  company,  and 
the  departments  are  limited  in  their  expenditures  to  the 
amount  of  the  appropriations  made  by  the  budget  commit- 


430 


BUDGETARY  CONTROL 


tee  after  consideration  of  the  departmental  estimates,  an 
effective  method  of  control  is  available. 

Formulation  of  a  Financial  Program 

The  demand  for  capital  is  an  imperative  one.  When 
funds  are  needed  their  procurement  cannot  be  long  delayed. 
To  insure  that  it  will  be  possible  to  secure  them  when  needed, 
it  is  necessary  to  determine  in  advance  the  amount  required 
and  the  time  when  required,  so  that  plans  may  be  made  for 
their  procurement. 

It  is  possible  to  do  this  in  a  systematic  way  only  when 
comprehensive  and  accurate  statements  of  the  plans  of  all 
the  departments  are  available,  so  that  estimates  of  cash  re- 
ceipts and  disbursements  which  will  result  from  these  plans 
can  be  made  and  a  program  formulated  for  the  procurement 
of  any  excess  of  disbursements  over  receipts. 

Coordination  of  All  the  Activities  of  the  Business 

The  previous  discussion  has  emphasized  the  close  rela- 
tionship between  the  activities  of  all  the  departments  of  a 
business.  This  relationship  is  so  close  that  no  one  depart- 
ment can  carry  on  its  activities  properly  without  a  consid- 
eration of  the  activities  of  one  or  more  of  the  other  depart- 
ments. Neither  can  the  executives  of  a  business  judge 
properly  the  past  or  contemplated  activities  of  any  one  de- 
partment independently  of  the  activities  of  the  other  depart- 
ments. 

To  make  possible  the  formulation  of  a.  well-balanced 
program  for  the  business  as  a  whole,  it  is  essential  that  the 
plans  of  all  the  departments  be  presented  for  executive  con- 
sideration and  that  the  plans  of  the  several  departments  be 
modified,  if  necessary,  in  order  to  bring  about  coordination. 
This  can  best  be  accomplished  by  the  submission  of  formal 
estimates  to  a  budget  committee,  and  the  formulation  of 


ADVANTAGES  AND  LIMITATIONS 


421 


these  into  a  budgetary  program,  which  will  be  enforced  and 
controlled  in  some  such  manner  as  that  discussed  in  the  pre- 
ceding chapters. 

The  Limitations  of  Budgetary  Control 

WewHor  Consideration 

It  is  as  essential  that  the  limitations  of  budgetary  con- 
trol be  understood  as  that  the  benefits  which  may  be  derived 
from  it  be  realized.  Unless  this  be  true  the  following  re- 
sults are  apt  to  happen: 

1.  Too  much  will  be  expected  from  the  budgetary  program,  and 

when  it  fails  to  fulfil  expectations  it  may  be  thought  useless 
and  abandoned. 

2.  Too  much  reliance  may  be  placed  on  its  operation  which  may 

result  in  too  little  emphasis  on  other  methods  of  administrative 
control. 

3.  It  may  be  followed  blindly  which  may  bring  results  more  detri- 

mental than  those  which  arise  from  its  absence. 

Important  Limitations 

The  most  important  and  significant  limitations  of  budg- 
etary control  are  the  following : 

1.  The  budget  program  is  based  on  estimates.  Esti- 
mates cannot  be  made  which  are  entirely  accurate,  and  con- 
sequently they  must  be  used  with  judgment  and  not  fol- 
lowed arbitrarily.  It  is  also  necessary  that  provision  be 
made  for  frequent  revisions  of  these  estimates  as  actual 
performance  shows  variations  from  the  estimated  perform- 
ance. 

2.  Budgetary  plans  will  not  execute  themselves.  After 
budgets  are  prepared,  every  possible  effort  must  be  made  to 
equal  or  exceed  them.  Detail  plans  must  be  made  for  their 
attainment  and  these  plans  must  be  enforced  rigidly. 

3.  Budgetary  control  cannot  take  the  place  of  admin- 


422 


BUDGETARY  CONTROL 


istration.  It  is  not  its  purpose  to  deprive  executives  of  the 
necessary  freedom  of  action  which  is  essential  to  progressive 
management.  Its  purpose  is  to  provide  the  information 
on  which  administrative  decisions  and  administrative  con- 
trol are  based. 

4.  Budgetary  control  cannot  be  perfected  immediately. 
The  procedure  called  for  by  the  budgetary  program  is 
usually  new  to  executives  and  it  takes  time  to  train  them  to 
make  and  use  properly  estimates  of  future  operations.  Too 
much  should  not  be  expected  at  the  beginning  of  budgetary 
control.  In  many  cases  it  is  desirable  to  install  budgetary 
control  gradually  so  that  the  executives  may  be  educated  to 
its  needs  and  purposes. 

Summary 

The  advantages  to  be  derived  from  budgetary  control 
may  be  stated  in  outline  form  as  follows: 

1.  Coordination  of  Sales  and  Production: 

(a)  By  estimating  sales  possibilities  and  planning  production 

to  produce  the  goods  necessary  to  meet  these  pos- 
sibilities. 

(b)  By  limiting  the  production  to  the  amount  necessary  to 

meet  probable  sales  demands  as  shown  by  the  sales  esti- 
mate, thus  preventing  an  excess  of  inventory  of  finished 
product. 

2.  Formulation  of  a  Profitable  Sales  and  Production  Pro- 

gram: 

(a)  By  determining  the  lines  of  goods  most  desirable  for  a 

well-rounded  sales  program  and  adapting  production,  in 
so  far  as  is  consistent  with  the  following  paragraph,  to 
produce  the  necessary  quantity  of  these  lines. 

(b)  By  determining  the  lines  of  goods  most  desirable  for  a 

well-rounded  production  program  and  planning  sales,  in 
so  far  as  is  consistent  with  the  preceding  paragraph,  to 
sell  the  amount  of  these  lines  necessary  to  secure  eco- 
nomical production. 


ADVANTAGES  AND  LIMITATIONS 


423 


3.  Coordination  of  Sales  and  Production  with  Finances: 

(a)  By  considering  the  contemplated  sales  and  production 

programs  in  terms  of  financial  requirements  and  revising 
these  programs,  if  necessary,  to  reduce  the  financial 
requirements  to  correspond  to  the  financial  program 
which  is  deemed  possible  and  desirable. 

(b)  By  determining  the  financial  requirements  of  the  sales 

and  production  programs  as  revised  in  the  manner  pre- 
scribed in  the  preceding  paragraph,  and  planning  to  se- 
cure funds  to  meet  these  requirements. 

4.  Proper  Control  of  Expenditures: 

(a)  By  requiring  the  preparation  by  each  department  head  of 

an  estimate  of  the  expenditures  of  his  department  during 
the  budget  period. 

(b)  By  requiring  the  submission  of  these  estimates  to  the 

budget  committee  for  consideration  and  approval. 

(c)  By  the  prohibition  of  any  expenditures  in  excess  of  the 

departmental  estimates  without  the  permission  of  the 
budget  committee. 

(d)  By  requiring  the  submission  of  monthly  reports  showing  a 

comparison  between  the  actual  expenditures  for  the 
month  and  the  estimated. 

5.  Formulation  of  a  Financial  Program  : 

(a)  By  the  estimating  of  cash  receipts  for  each  month 

based  on  the  sales  program  and  the  estimate  of  col- 
lections. 

(b)  By  the  estimating  of  cash  disbursements  for  each 

month  based  on  the  production,  purchasing,  plant  and 
equipment,  and  departmental  expense  budgets. 

(c)  By  determining  the  excess  of  disbursements  over  receipts 

and  the  preparation  of  a  financial  program  which  will 
secure  funds  to  provide  for  this  excess. 

6.  Coordination  of  All  the  Activities  of  the  Business-. 

(a)  By  the  preparation  by  each  department  of  an  estimate  of 

its  activities  during  the  budget  period. 

(b)  By  the  study  of  these  departmental  estimates  by  the 

departmental  executives  and  the  budget  committee. 


424 


BUDGETARY  CONTROL 


(c)  By  the  modification  of  the  activities  of  each  department 

to  the  end  that  they  coordinate  with  the  activities  of 
each  other  department. 

(d)  By  the  preparation  of  an  estimated  balance  sheet  and 

an  estimated  statement  of  profit  and  loss  showing  the 
anticipated  results  of  the  operations  provided  for  by  the 
budgetary  program. 

(e)  By  the  formulation  of  plans  and  policies  which  will  make 

possible  the  attainment  of  the  estimated  results  as 
shown  by  the  estimated  financial  reports  prepared  as 
directed  in  the  preceding  paragraph. 

The  limitations  of  budgetary  control  may  be  stated  in 
outline  form  as  follows:  • 

1.  The  budgetary  program  is  based  on  estimates. 

2.  Budgetary  plans  will  not  execute  themselves. 

3.  Budgetary  control  cannot  take  the  place  of  administration. 

4.  Budgetary'  control  cannot  be  perfected  immediately. 


CHAPTER  XXVI 


BUDGETARY  CONTROL  FOR  NON-COMMERCIAL 
ENTERPRISES 

Scope  of  Previous  Chapters 

The  discussion  in  the  preceding  chapters  has  been  con- 
fined to  a  consideration  of  the  use  of  budgetary  control  in 
the  administration  of  the  commercial  or  profit-seeking  enter- 
prise.   This  has  been  done  for  the  following  reasons : 

1.  It  is  for  such  enterprises  that  budgetary  control  is  most  urgently 

needed  at  the  present  time. 

2.  The  development  of  budgetary  control  in  connection  with  such 

enterprises  has  been  very  slow  and  standard  methods  have  not 
been  formulated. 

3.  The  literature  dealing  with  the  application  of  budgetary  control 

of  these  enterprises  is  limited.  There  is  considerable  litera- 
ture dealing  with  the  various  parts  of  the  budgetary  procedure, 
but  so  far  as  the  author  is  aware  this  text  is  the  first  attempt 
to  discuss  the  budgetary  process  as  a  whole.  On  the  other 
hand,  there  is  a  considerable  body  of  literature  dealing  with 
budgetary  control  of  non-commercial  enterprises. 

For  these  reasons  it  is  thought  that  this  text  will  best 
serve  its  purpose  by  emphasizing  the  possible  uses  of  budget- 
ary control  by  the  commercial  enterprise  and  the  possible 
methods  by  which  its  installation  by  such  businesses  may  be 
effected.  It  is  well  to  see,  however,  the  other  uses  which 
may  be  made  of  it. 

Varied  Uses  of  Budgetary  Control 

Budgetary  control  has  long  been  practiced  by  govern- 
mental units,  educational  institutions,  and  similar  organiza- 
tions.   Religious,  social,  and  charitable  institutions,  such 

425 


426 


BUDGETARY  CONTROL 


as  churches,  Y.  M.  C.  A.'s,  and  social  service  agencies,  are 
accustomed  to  prepare  budgets,  although  in  some  cases  they 
are  not  carefully  prepared  nor  rigidly  enforced.  There  has 
been  a  considerable  body  of  literature  produced  treating  of 
its  use  for  these  purposes  and  this  literature  is  readily  avail- 
able to  the  reader. 

Although  it  is  not  thought  worth  while  to  enter  into  a 
detailed  discussion  of  budgetary  control  for  non-commer- 
cial enterprises,  a  brief  description  is  given  in  this  chap- 
ter of  its  use  in  connection  with  governmental  units  and 
educational  institutions,  with  the  hope  that  some  benefit  may 
be  obtained  by  a  comparison  between  the  methods  employed 
in  these  cases  and  those  suggested  for  commercial  enter- 
prises in  the  preceding  chapters. 

Budgetary  Control  for  Governmental  Units 

A  possible  procedure  to  be  followed  in  the  formulation 
and  execution  of  a  budget  for  a  city,  state,  or  national  gov- 
ernment, stated  in  outline  form,  is  as  follows: 

1 .  Some  time  before  the  beginning  of  the  fiscal  year  each 
department  prepares  an  estimate  of  its  expenditures  for  the 
year.  For  instance,  in  a  state  government,  the  State  De- 
partment, the  Treasury  Department,  the  Department  of 
Justice,  etc.,  will  prepare  such  an  estimate.  The  depart- 
ment head  will  base  his  estimate  on  the  estimates  submitted 
by  the  bureau  chiefs  within  his  department. 

2.  The  head  of  the  department  will  transmit  this  esti- 
mate with  his  approval  to  some  official,  usually  the  Treas- 
urer, Comptroller,  Director  of  Finance,  or  Director  of  the 
Budget,  who  is  designated  by  the  law  to  receive  the  separate 
estimates  and  formulate  them  into  a  combined  estimate  for 
all  departments.  For  brevity,  we  shall  refer  to  this  execu- 
tive as  the  Director  of  the  Budget  in  the  following  discussion. 

3.  The  Director  of  the  Budget,  prepares  an  estimate  of 


NON-COMMERCIAL  ENTERPRISES  427 

the  revenue  for  the  fiscal  year.  He  then  submits  a  report 
to  the  chief  executive  (the  Mayor,  Governor,  or  President) 
showing  a  comparison  of  the  estimated  expenditures  with 
the  estimated  revenues.  -  - 

4.  The  chief  executive,  and  in  many  cases  a  Board  of 
Review,  Board  of  Estimate  and  Review,  or  Cabinet,  con- 
sider the  estimates  received  from  the  Director  of  the 
Budget.  The  departmental  heads  may  be  called  into  con- 
ference to  give  reasons  for  any  increases  requested  by  their 
departments. 

5.  If  the  estimated  expenditures  exceed  the  estimated 
revenues,  one  of  the  following  must  be  done: 

(a)  Expenditures  may  be  reduced.    This  invoh'cs  a  decrease  in  the 

estimates  of  one  or  more  departments.  The  Chief  Executive 
or  his  advisory  board  must  decide  which  of  the  departmental 
estimates  should  be  decreased. 

(b)  Revenue  may  be  increased.    This  necessitates  the  de\'isifig  of 

new  methods  of  taxation  or  the  increasing  of  the  present 
rates  of  taxation. 

(c)  Additional  funds  may  be  secured  from  loans.    This  results  in 

an  increase  of  the  indebtedness  of  the  government. 

6.  The  chief  executive  transmits  the  budget  as  approved 
by  him  to  the  legislative  body  responsible  for  transforming 
it  into  law.  He  may  accompany  it  with  recommendations 
with  reference  to  methods  of  raising  new  revenue  if  this  is 
necessary,  or  with  reference  to  the  decrease  of  taxes  if  this 
is  possible. 

7.  The  proposed  budget  is  considered  by  the  legislative 
body  and  such  changes  made  as  it  deems  fit.  Usually  the 
changes  permitted  are  limited  by  law.  In  some  cases  the 
legislative  body  is  given  authority  to  decrease  and  strike 
out  items,  but  cannot  increase  or  add  items. 

8.  When  the  budget  is  approved  by  the  legislative  body, 
it  becomes  the  working  program  for  all  the  departments  for 


428 


BUDGETARY  CONTROL 


the  fiscal  period.  No  department  is  permitted  to  exceed 
its  budget  allowance  without  a  special  dispensation  of  the 
legislative  body.  In  some  cases  there  is  an  "emergency 
fund"  included  in  the  budget  and  put  at  the  disposal  of 
the  chief  executive.  He  may  make  allowances  from  this 
fund  to  departments  which  in  his  opinion  are  in  need 
of  additional  funds.  The  amount  of  this  fund  is  usually 
small. 

9.  Proper  records  are  kept  that  all  expenditures  of  each 
department  may  be  charged  against  its  budget  or  "appro- 
priation." Periodic  reports  are  made  to  a  representative  of 
the  chief  executive,  showing  a  comparison  between  estimated 
expenditures  and  actual  expenditures. 

It  will  be  understood,  of  course,  that  the  procedure 
stated  in  the  foregoing  outline  is  intended  to  be  indicative 
only.  The  procedure  varies  somewhat  in  different  govern- 
mental units. 

Budgetary  Control  of  the  National  Government 

The  "Budget  and  Accounting  Act,"  which  establishes 
budgetary  control  for  the  federal  government,  was  approved 
by  the  President  on  June  10,  1921.  The  complete  act  is 
given  in  Appendix  A.  The  most  important  features  of  this 
act  for  our  purposes  are  the  following: 

1 .  It  places  the  final  authority  and  responsibility  for  the 
preparation  and  enforcement  of  the  budget  in  the  Presi- 
dent who  is  the  chief  executive  of  the  administrative  divi- 
sion of  the  government. 

2.  It  sets  up  a  Budget  Bureau  which  is  responsible  for 
the  preparation  and  enforcement  of  the  budgetary  procedure. 
The  executive  head  of  this  bureau  is  termed  the  Director  of 
the  Budget,  and  reports  directly  to  the  President.  In  this 
sense  he  may  be  termed  a  staff  assistant  to  the  President. 
In  so  far  as  the  President  delegates  to  him  authority  in  the 


NON-COMMERCIAL  ENTERPRISES  429 

enforcement  of  the  budget,  he  acts  as  an  executive  assistant 
instead  of  a  staff  assistant, 

3.  It  sets  up  a  budget  officer  in  each  bureau  who  is  re- 
sponsible for  preparing  the  original  estimate  for  his  bureau. 
This  results  in  placing  the  responsibility  for  initiating  each 
budget  on  the  unit  which  is  responsible  for  its  per- 
formance. 

4.  It  prescribes  that  each  bureau  chief  will  consider  the 
budget  as  prepared  by  his  budget  officer  and  after  he  has 
approved  it  transmit  it  to  the  department  chief.  The  de- 
partment head  revises  the  estimates  of  the  bureaus  if  he 
thinks  this  is  necessary,  and  then  combines  these  to  make 
the  estimate  of  his  department. 

5.  It  prescribes  that  each  department  head  will  transmit 
the  estimates  of  his  department  to  the  Director  of  the 
Budget.  The  latter  will  revise  the  departmental  estimates 
if  necessary,  and  will  then  combine  these  to  make  the  com- 
plete estimate  on  expenditures.  He  will  transmit  this  to- 
gether with  the  estimate  of  revenues  to  the  President,  who 
will  make  any  changes  which  he  thinks  necessary  and  sub- 
mit them  with  his  approval  to  Congress. 

6.  It  creates  a  Comptroller  General  who  is  responsible 
for  the  form  of  the  records  and  the  procedures  of  the  various 
departments,  and  for  exercising  control  over  the  disburse- 
ments made  under  the  appropriations  which  are  made  in 
response  to  the  budget. 

It  can  be  seen  from  the  foregoing  that  the  act  sets  up  in 
general  terms  the  procedure  to  be  followed  in  the  prepara- 
tion and  enforcement  of  the  national  budget. 

Budgetary  Control  of  State  Governments 

The  budgetary  procedure  of  the  several  states  varies  to  a 
considerable  degree.  The  modem  tendency  is  towards  a 
more  complete  and  comprehensive  planning  of  financial 


430 


BUDGETARY  CONTROL 


Operations  than  that  formerly  employed.  In  recent  years 
there  has  been  some  tendency  towards  a  classification  of  the 
administrative  activities  of  the  state  on  a  functional  basis, 
and  the  creation  of  functional  departments  to  carry  on  these 
activities.  In  those  few  states  which  have  followed  this 
plan  there  is  usually  created  a  department  of  finance  in 
which  is  vested  inter  alia  the  responsibility  for  the  prepara- 
tion and  enforcement  of  the  budget. 

Appendix  B  gives  an  extract  from  the  "Administrative 
Code  "  of  the  state  of  Ohio,  which  was  approved  by  the  Gov- 
ernor of  the  State  on  April  26,  1921.  This  extract  shows 
the  duties  of  the  Department  of  Finance  as  defined  in  the 
law.  This  extract  is  interesting  not  only  from  the  view- 
point of  budgetary  control,  but  also  from  the  viewpoint  of 
administrative  control  in  general. 

Budgetary  Control  for  Educational  Institutions 

Budgetary  procedure  will  vary  somewhat  as  between 
the  small  college  and  the  large  university,  and  it  will  be 
slightly  different  in  the  endowed  institution  from  that  of  the 
institution  supported  by  public  funds. 

To  indicate  briefly  the  principal  considerations  involved 
in  the  adoption  of  a  procedure  for  an  educational  institution, 
a  state  university  will  serve  our  purpose. 

Budgetary  Control  for  University 

The  president  of  the  university  is  responsible  for  the 
preparation  of  the  annual  budget  and  its  submission  to  the 
board  of  trustees  for  approval.  In  its  preparation  he  may 
employ  various  subordinates.  The  subordinates  which 
may  be  employed  and  the  procedure  which  they  may  fol- 
low in  performing  their  tasks  may  be  understood  better  by 
considering  separately  (a)  the  estimate  of  income,  and  (b) 
the  estimate  of  expenditures. 


NON-COMMERCIAL  ENTERPRISES 


The  Estimate  of  Income 

The  income  of  a  state  university  may  be  derived  from 
the  following  sources : 

1 .  United  States  land  grante 

2.  Student  fees 

3.  Departmental  sales 

4.  Gifts 

5.  Appropriations 

The  income  to  be  derived  from  United  States  land  grants 
is  not  difficult  to  determine,  for  it  is  usually  fairly  uniform 
in  amount.  The  income  from  student  fees  is  dependent  on 
the  number  of  students  enrolled.  Since  the  attendance  of 
a  state  university  almost  invariably  increases  each  year,  it 
is  not  difficult  to  determine  the  minimum  amount  of  this 
item  of  income.  It  is,  of  course,  impossible  to  determine 
the  exact  amount  to  be  received  from  this  source. 

Departmental  sales  arise  chiefly  from  sales  of  the  school 
of  agriculture,  and  the  income  from  this  source  must  be 
based  on  an  estimate  of  the  quantity  of  product  and  services 
offered  for  sale  and  the  probable  price  to  be  obtained  for 
them.  Possible  sales  of  all  departments  and  colleges  must 
be  considered.  The  income  from  gifts  is  ordinarily  not 
large  and  is  usually  restricted  in  its  uses;  so  it  has  little 
effect  on  the  general  budget. 

The  income  from  appropriations  cannot  be  determined 
until  after  the  action  of  the  legislature.  The  university 
ordinarily  requests  appropriations  for  sufficient  amounts  to 
meet  the  excess  of  disbursements  over  receipts  as  shown 
by  its  budget.  In  most  cases  more  is  requested  than  is 
obtained,  and  this  necessitates  a  reduction  in  the  original 
estimate  of  expenditures. 

The  business  manager  or  comptroller  can  best  make  the 
estimate  of  income.  He  may  consult  other  executives  in  its 
preparation.    After  its  completion  he  will  transmit  it  to  the 


432  BUDGETARY  CONTROL 

president,  who  will  combine  it  with  the  estimate  of  expend- 
itures to  form  the  budget  which  he  submits  to  the  board  of 
trustees. 

Estimate  of  Disbursements 

The  expenditures  of  a  university  may  be  grouped  broadly 
as  follows: 

1.  General  Administration,  including  the  salaries  of  "business" 

employees  and  clerical  and  stenographic  assistants  in  all  de- 
partments. 

2.  Physical  Plant  Operation  and  Maintenance 

3.  Capital  Additions 

4.  Teaching  and  Research 

(a)  Library 

(b)  Supplies 

(c)  Instruction 

General  Administrative  Expenses 

The  estimate  of  general  administrative  expense  will 
be  prepared  by  the  controller.  As  a  basis  for  this  estimate 
he  will  receive  an  estimate  from  each  department  and  ad- 
ministrative unit.  The  controller  will  indicate  such  revi- 
sions as  he  thinks  are  necessary  and  transmit  the  combined 
estimates  to  his  superior  officer,  which  may  be  the  president 
or  the  business  manager.  In  any  case  the  president  will 
make  such  revisions  as  he  thinks  are  necessary  and  submit 
the  estimate  with  his  recommendations  to  the  board  of 
trustees. 

Physical  Plant  Operation  and  Maintenance 

The  superintendent  of  buildings  and  grounds  will  pre- 
pare the  original  estimate  for  expenditures  for  physical 
plant  operation  and  maintenance.  In  its  preparation  he 
will  be  assisted  by  the  purchasing  agent,  who  will  indicate 
the  cost  of  materials  and  supplies  needed  by  the  program. 


NON-COMMERCIAL  ENTERPRISES 


433 


If  the  university  has  a  plant  engineer  he  may  also  assist  in 
the  preparation  of  the  estimate. 

This  estimate  will  be  transmitted  to  the  business  man- 
ager who  makes  such  revisions  as  he  thinks  necessary  and 
transfers  it  to  the  president,  who  treats  it  likewise  and  sub- 
mits it  to  the  board  of  trustees. 

Capital  Additions 

The  additions  to  property  are  usually  made  as  the  result 
of  appropriations  which  are  granted  for  the  procurement  or 
construction  of  specific  property.  Usually  the  president 
presents  a  building  program  to  the  board  of  trustees,  and  if 
it  is  adopted  an  attempt  is  made  to  secure  appropriations 
for  the  construction  of  the  buildings  called  for  by  the  pro- 
gram. 

In  many  cases  the  program  covers  a  period  of  several 
years  but  indicates  the  buildings  which  are  most  urgent. 
Appropriations  may  be  requested  in  the  order  indicated  by 
the  program.  In  presenting  the  program  to  the  board  of 
trustees  and  later  to  the  legislature,  it  is  necessary  to  show 
estimates  of  cost.  These  estimates  may  be  prepared  by  the 
university  architect  in  cooperation  with  the  university  en- 
gineer and  the  purchasing  agent.  In  some  cases  outside 
counsel  may  be  employed  to  make  these  estimates. 

After  appropriations  are  secured,  contracts  will  be  let  for 
construction  and  the  controller  and  business  manager  will 
supervise  the  expenditure  of  funds  under  the  appropriation. 

Teaching  and  Research 

The  expenditures  under  this  heading  may  be  subdivided 
to  show  separately  the  cost  of  the  following : 

1.  Maintenance  of  library 

2.  Supplies  and  equipment 

3.  Instruction 

28 


434  BUDGETARY  CONTROL 


NON-COMMERCIAL  ENTERPRISES 


435 


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BUDGETARY  CONTROL 


The  director  of  the  libraries  will  prepare  an  estimate  of 
the  cost  of  maintaining  the  library.  He  will  also  make  an 
estimate  of  the  cost  of  the  necessary  additions  based  on  the 
requests  of  departments.  In  some  cases  there  is  a  faculty 
committee  which  supervises  such  expenditures  and  passes 
on  these  requests.  In  some  universities  there  are  vari- 
ous other  committees  which  pass  on  various  kinds  of 
expenditures. 

After  the  estimate  is  prepared  it  will  be  transmitted  to 
the  president,  who  will  submit  it  to  the  board  of  trustees  for 
approval. 

The  estimate  of  supplies  required  by  each  department 
will  be  prepared  by  the  head  of  each  department  and  trans- 
mitted by  him  to  the  business  manager,  who  will  trans- 
mit it  to  the  president,  who  will  transmit  it  to  the  board  of 
trustees. 

In  the  preparation  of  the  estimate  of  instruction  cost 
for  a  university,  a  procedure  similar  to  the  following  may 
be  used : 

1.  An  estimate  will  be  prepared  by  each  department  showing  the 

salaries  recommended  for  each  member  thereof.  A  very 
useful  form  for  the  pre;paration  of  this  estimate  is  shown  in 
Figure  52. 

2.  The  budget  as  prepared  by  the  department  will  be  forwarded  by 

the  head  of  the  department  to  the  dean  of  the  college  of  which 
the  department  is  a  part. 

3.  The  budget  as  approved  by  the  dean  of  the  college  will  be  trans- 

ferred to  the  budget  committee.  This  committee  may  be  com- 
posed of  the  deans  of  all  the  colleges.  If  the  university  has  a 
functional  organization,  it  will  be  composed  of  the  staff  officers 
in  the  office  of  the  president.  The  president  will  be  chairman 
of  the  committee. 

4.  The  budget  committee  will  consider  carefully  the  budget  of  each 

department  and  of  each  college.  When  necessary  it  may  call 
into  conference  the  heads  of  departments  and  deans  of  the 
colleges.    In  the  consideration  of  the  separate  budgets  it  will 


NON-COMMERCIAL  ENTERPRISES  437 

have  in  mind  the  budget  of  the  university  as  a  whole,  which  it 
will  prepare  from  the  separate  budgets. 

5.  After  the  budget  has  been  approved  by  the  budget  committee, 

it  will  be  transmitted  to  the  president  of  the  university.  The 
president  will  submit  the  budget  to  the  board  of  trustees  with 
such  recommendations  as  he  may  deem  desirable. 

6.  If  it  is  desired  to  make  any  revisions  in  the  original  budget,  the 

same  procedure  will  be  followed  as  in  the  making  of  the  original 
budget. 

In  the  departmental  salary  budget  (Figure  52a,  b,  c), 
Section  I  is  useful  in  that  it  shows  the  "class  hours"  re- 
quired to  carry  the  desired  program.  It  serves  as  a  basis 
for  estimating  the  required  teaching  staff.  Cohimn  (5) 
of  this  section  must  be  equal  to  column  (2)  of  Section  II, 
and  column  (2)  of  Section  III.  Section  II  is  useful  in 
showing  the  disposition  of  instructors*  time.  If  the  budget 
committee  studies  this  section  in  connection  with  Section 
I,  it  can  judge  intelligently  the  claims  of  departments  for 
additions  to  staff.  Sections  III  and  IV  serve  as  a  basis 
for  the  preparation  of  the  financial  budget. 

Budgetary  Procedure 

A  definite  procedure  should  be  established  for  the  prepa- 
ration of  all  the  foregoing  budgets,  so  that  they  will  all  reach 
the  president  at  the  proper  time  and  he  can  transmit  them 
to  the  board  of  trustees  at  the  same  time. 

Summary 

No  attempt  has  been  made  in  this  chapter  to  discuss  a 
complete  procedure  for  the  preparation  and  execution  of 
the  budget  of  a  non-commercial  organization.  To  do  this 
would  require  a  separate  volume.  Neither  is  it  intended 
to  offer  the  procedures  briefly  outlined  in  this  chapter  as 
those  which  can  be  adopted  in  toto  by  any  particular  or- 
ganization, although  the  procedures  given  are  adapted 


« 


438  BUDGETARY  CONTROL 

from  those  with  which  the  author  is  famiUar.  It  is  in- 
tended that  this  chapter  be  only  suggestive  of  methods 
employed  by  non-commercial  enterprises  in  seeking  ad- 
ministrative control  through  the  operation  of  a  budgetary 
system. 


APPENDIX  A 


THE  BUDGET  AND  ACCOUNTING  ACT 

Following  is  the  law,  approved  by  the  President  June 
lo,  192 1,  which  establishes  budgetary  control  for  the  fed- 
eral government. 

An  Act  to  provide  a  national  budget  system  and  an  independent  audit 
of  Government  accounts,  and  for  other  purposes. 

Title  I — Definitions 

Section  i.  This  Act  may  be  cited  as  the  "Budget  and  Accounting 
Act,  192 1." 

Sec.  2.   When  used  in  this  Act — 

The  terms  "  department  and  establishment "  and  "department  or  estab- 
lishment" mean  any  executive  department,  independent  commission, 
board,  bureau,  ofifice,  agency,  or  other  establishment  of  the  Government, 
including  the  municipal  government  of  the  District  of  Columbia,  but  do  not 
include  the  Legislative  Branch  of  the  Government  or  the  Supreme  Court 
of  the  United  States; 

The  term  "the  Budget"  means  the  Budget  required  by  section  201  to 
be  transmitted  to  Congress ; 

The  term  "Bureau"  means  the  Bureau  of  the  Budget; 

The  term  "  Director"  means  the  Director  of  the  Bureau  of  the  Budget; 
and 

The  term  "Assistant  Director"  means  the  Assistant  Director  of  the 
Bureau  of  the  Budget. 

Title  II — The  Budget 

Sec.  201.  The  President  shall  transmit  to  Congress  on  the  first  day  of 
each  regular  session,  the  Budget,  which  shall  set  forth  in  summary  and  in 
detail : 

(a)  Estimates  of  the  expenditures  and  appropriations  necessary  in  his 
judgment  for  the  support  of  the  Government  for  the  ensuing  fiscal  year; 
except  that  the  estimates  for  such  year  for  the  Legislative  Branch  of  the 
Government  and  the  Supreme  Court  of  the  United  States  shall  be  trans- 

439 


I 


440 


APPENDIX 


mitted  to  the  President  on  or  before  October  1 5th  of  each  year,  and  shall 
be  included  by  him  in  the  Budget  without  revision; 

(b)  His  estimates  of  the  receipts  of  the  Government  during  the  ensuing 
fiscal  year,  under  (i)  laws  existing  at  the  time  the  Budget  is  transmitted 
and  also  (2)  under  the  revenue  proposals,  if  any,  contained  in  the  Budget; 

(c)  The  expenditures  and  receipts  of  the  Government  during  the  last 
completed  fiscal  year; 

(d)  Estimates  of  the  expenditures  and  receipts  of  the  Government  dur- 
ing the  fiscal  year  in  progress; 

(e)  The  amount  of  annual,  permanent,  or  other  appropriations,  includ- 
ing balances  of  appropriations  for  prior  fiscal  years,  available  for  expendi- 
ture during  the  fiscal  year  in  progress,  as  of  November  i  of  such  year; 

(f)  Balanced  statements  of  (i)  the  condition  of  the  Treasury  at  the  end 
of  the  last  completed  fiscal  year,  (2)  the  estimated  condition  of  the  Treas- 
ury at  the  end  of  the  fiscal  year  in  progress,  and  (3)  the  estimated  condi- 
tion of  the  Treasury  at  the  end  of  the  ensuing  fiscal  year  if  the  financial 
proposals  contained  in  the  Budget  are  adopted; 

(g)  All  essential  facts  regarding  the  bonded  and  other  indebtedness  of 
the  Government;  and 

(h)  Such  other  financial  statements  and  data  as  in  his  opinion  are 
necessary  or  desirable  in  order  to  make  known  in  all  practicable  detail  the 
financial  condition  of  the  Government. 

Sec.  202.  (a)  If  the  estimated  receipts  for  the  ensuing  fiscal  year  con- 
tained in  the  Budget,  on  the  basis  of  laws  existing  at  the  time  the  Budget 
is  transmitted,  plus  the  estimated  amounts  in  the  Treasury  at  the  close  of 
the  fiscal  year  in  progress,  available  for  expenditure  in  the  ensuing  fiscal 
year,  are  less  than  the  estimated  expenditures  for  the  ensuing  fiscal  year 
contained  in  the  Budget,  the  President  in  the  Budget  shall  make  recom- 
mendations to  Congress  for  new  taxes,  loans,  or  other  appropriate  action 
to  meet  the  estimated  deficiency. 

(b)  If  the  aggregate  of  such  estimated  receipts  and  such  estimated 
amounts  in  the  Treasury  is  greater  than  such  estimated  expenditures  for 
the  ensuing  fiscal  year,  he  shall  make  such  recommendations  as  in  his  opin- 
ion the  public  interests  require. 

Sec.  203.  (a)  The  President  from  time  to  time  may  transmit  to  Con- 
gress supplemental  or  deficiency  estimates  for  such  appropriations  or  ex- 
penditures as  in  his  judgment  (i)  are  necessary  on  account  of  laws  enacted 
after  the  transmission  of  the  Budget,  or  (2)  are  otherwise  in  the  public 
interest.  He  shall  accompany  such  estimates  with  a  statement  of  the 
reasons  therefor,  including  the  reasons  for  their  omission  from  the  Budget. 


THE  BUDGET  AND  ACCOUNTING  ACT 


441 


(b)  Whenever  such  supplemental  or  deficiency  estimates  reach  an 
aggregate  which,  if  they  had  been  contained  in  the  Budget,  would  have 
required  the  President  to  make  a  recommendation  under  subdivision  (a)  of 
section  202,  he  shall  thereupon  make  such  recommendation. 

Sec.  204.  (a)  Except  as  otherwise  provided  in  this  Act,  the  contents, 
order,  and  arrangement  of  the  estimates  of  appropriations  and  the  state- 
ments of  expenditures  and  estimated  expenditures  contained  in  the  Budget 
or  transmitted  under  section  203,  and  the  notes  and  other  data  submitted 
therewith,  shall  conform  to  the  requirements  of  existing  law. 

(b)  Estimates  for  lump-sum  appropriations  contained  in  the  Budget 
or  transmitted  under  section  203  shall  be  accompanied  by  statements  show- 
ing, in  such  detail  and  form  as  may  be  necessary  to  inform  Congress,  the 
manner  of  expenditure  of  such  appropriations  and  of  the  corresponding 
appropriations  for  the  fiscal  year  in  progress  and  the  last  completed  fiscal 
year.  Such  statements  shall  be  in  lieu  of  statements  of  like  character  now 
required  by  law. 

Sec.  205.  The  President,  in  addition  to  the  Budget,  shall  transmit  to 
Congress  on  the  first  Monday  in  December,  192 1,  for  the  service  of  the 
fiscal  year  ending  June  30,  1923,  only,  an  alternative  budget,  which  shall  be 
prepared  in  such  form  and  amounts  and  according  to  such  system  of  classi- 
fication and  itemization  as  is,  in  his  opinion,  most  appropriate,  with  such 
explanatory  notes  and  tables  as  may  be  necessary  to  show  where  the 
various  items  embraced  in  the  Budget  are  contained  in  such  alternative 
budget. 

Sec.  206.  No  estimate  or  request  for  an  appropriation  and  no  request 
for  an  increase  in  an  item  of  any  such  estimate  or  request,  and  no  recommen- 
dation as  to  how  the  revenue  needs  of  the  Government  should  be  met,  shall 
be  submitted  to  Congress  or  any  committee  thereof  by  any  officer  or  em- 
ployee of  any  department  or  establishment,  imless  at  the  request  of  either 
House  of  Congress. 

Sec.  207.  There  is  hereby  created  in  the  Treasury  Department  a 
Bureau  to  be  known  as  the  Bureau  of  the  Budget.  There  shall  be  in  the 
Bureau  a  Director  and  an  Assistant  Director,  who  shall  be  appointed  by  the 
President  and  receive  salaries  of  $10,000  and  $7,500  a  year,  respectively. 
The  Assistant  Director  shall  perform  such  duties  as  the  Director  may  desig- 
nate, and  during  the  absence  or  incapacity  of  the  Director  or  during  a  va- 
cancy in  the  office  of  Director  he  shall  act  as  Director.  The  Bureau,  under 
such  rules  and  regulations  as  the  President  may  prescribe,  shall  prepare  for 
him  the  Budget,  the  alternative  Budget,  and  any  supplemental  or  deficiency 
estimates,  and  to  this  end  shall  have  authority  to  assemble,  correlate,  re- 


44^ 


APPENDIX 


vise,  reduce,  or  increase  the  estimates  of  the  several  departments  or  estab- 
lishments. 

Sec.  208.  (a)  The  Director,  under  such  rules  and  regulations  as  the 
President  may  prescribe,  shall  appoint  and  fix  the  compensation  of  attor- 
neys and  other  employees  and  make  expenditures  for  rent  in  the  District 
of  Columbia  printing,  binding,  telegrams,  telephone  ser\'ice,  law  books, 
books  of  reference,  periodicals,  stationery,  furniture,  office  equipment, 
other  supplies,  and  necessary  expenses  of  the  office,  within  the  appropria- 
tions made  therefor. 

(b)  No  person  appointed  by  the  Director  shall  be  paid  a  salary  at  a 
rate  in  excess  of  $6,000  a  year,  and  not  more  than  four  persons  so  appointed 
shall  be  paid  a  salary  at  a  rate  in  excess  of  $5,000  a  year. 

(c)  All  employees  in  the  Bureau  whose  compensation  is  at  a  rate  of 
$5,000  a  year  or  less  shall  be  appointed  in  accordance  with  the  civil-service 
laws  and  regulations. 

(d)  The  provisions  of  law  prohibiting  the  transfer  of  employees  of  execu- 
tive departments  and  independent  establishments  until  after  service  of 
three  years  shall  not  apply  during  the  fiscal  years  ending  June  30,  1921,  and 
June  30,  1922,  to  the  transfer  of  employees  to  the  Bureau. 

(e)  The  Bureau  shall  not  be  construed  to  be  a  bureau  or  office  created 
since  January  I,  1916,  so  as  to  deprive  employees  therein  of  the  additional 
compensation  allowed  civilian  employees  under  the  provisions  of  section  6 
of  the  Legislative,  Executive,  and  Judicial  Appropriation  Act  for  the 
fiscal  years  ending  June  30,  1921,  and  June  30,  1922,  if  otherwise  entitled 
thereto. 

Sec.  209.  The  Bureau,  when  directed  by  the  President,  shall  make  a 
detailed  study  of  the  departments  and  establishments  for  the  purpose  of 
enabling  the  President  to  determine  what  changes  (with  a  view  of  securing 
greater  economy  and  efficiency  in  the  conduct  of  the  public  service)  should 
be  made  in  (i)  the  existing  organization,  activities,  and  methods  of  busi- 
ness of  such  departments  or  establishments,  (2)  the  appropriations  there- 
for, (3)  the  assignment  of  particular  activities  to  particular  services,  or 
(4)  the  regrouping  of  services.  The  results  of  such  study  shall  be  embodied 
in  a  report  or  reports  to  the  President,  who  may  transmit  to  Congress  such 
report  or  reports  or  any  part  thereof  with  his  recommendations  on  the  mat- 
ters covered  thereby. 

Sec.  210  The  Bureau  shall  prepare  for  the  President  a  codification  of 
all  laws  or  parts  of  laws  relating  to  the  preparation  and  transmission  to 
Congress  of  statements  of  receipts  and  expenditures  of  the  Government  and 


THE  BUDGET  AND  ACCOUNTING  ACT  443 


of  estimates  of  appropriations.  The  President  shall  transmit  the  same  to 
Congress  on  or  before  the  first  Monday  in  December,  1921,  with  a  recom- 
mendation as  to  the  changes  which,  in  his  opinion,  should  be  made  in  such 
laws  or  parts  of  laws. 

Sec.  211.  The  powers  and  duties  relating  to  the  compiling  of  esti- 
mates now  conferred  and  imposed  upon  the  Division  of  Bookkeeping  and 
Warrants  of  the  office  of  the  Secretary  of  the  Treasury  are  transferred 
to  the  Bureau. 

Sec.  212.  The  Bureau  shall,  at  the  request  of  any  committee  of  either 
House  of  Congress  having  jurisdiction  over  revenue  or  appropriations, 
furnish  the  committee  such  aid  and  information  as  it  may  request. 

Sec.  213.  Under  such  regulations  as  the  President  may  prescribe,  (i) 
every  department  and  establishment  shall  furnish  to  the  Bureau  such  in- 
formation as  the  Bureau  may  from  time  to  time  require,  and  (2)  the  Di- 
rector and  the  Assistant  Director,  or  any  employee  of  the  Bureau  when 
duly  authorized,  shall,  for  the  purpose  of  securing  such  information,  have 
access  to,  and  the  right  to  examine,  any  books,  documents,  papers,  or  rec- 
ords of  any  such  department  or  establishment. 

Sec.  214.  (a)  The  head  of  each  department  and  establishment  shall 
designate  an  official  thereof  as  budget  officer  therefor,  who,  in  each  year 
under  his  direction  and  on  or  before  a  date  fixed  by  him,  shall  prepare  the 
departmental  estimates. 

(b)  Such  budget  officer  shall  also  prepare,  under  the  direction  of  the 
head  of  the  department  or  establishment,  such  supplemental  and  deficiency 
estimates  as  may  be  required  for  its  work. 

Sec.  215.  The  head  of  each  department  and  establishment  shall  revise 
the  departmental  estimates  and  submit  them  to  the  Bureau  on  or  before 
September  15  of  each  year.  In  case  of  his  failure  so  to  do,  the  President 
shall  cause  to  be  prepared  such  estimates  and  data  as  are  necessary  to 
enable  him  to  include  in  the  Budget  estimates  and  statements  in  respect 
to  the  work  of  such  department  or  establishment. 

Sec.  216.  The  departmental  estimates  and  any  supplemental  or  de- 
ficiency estimates  submitted  to  the  Bureau  by  the  head  of  any  department 
or  establishment  shall  be  prepared  and  submitted  in  such  form,  manner, 
and  detail  as  the  President  may  prescribe. 

Sec.  217.  For  expenses  of  the  establishment  and  maintenance  of  the 
Bureau  there  is  appropriated,  out  of  any  money  in  the  Treasury  not  other- 
wise appropriated,  the  sum  of  $225,000,  to  continue  available  during  the 
fiscal  year  ending  June  30,  1922. 


444 


APPENDIX 


Title  III — General  Accounting  Office 

Sec.  301.  There  is  created  an  establishment  of  the  Government  to  be 
known  as  the  General  Accounting  Office,  which  shall  be  independent  of  the 
executive  departments  and  under  the  control  and  direction  of  the  Comp- 
troller General  of  the  United  States.  The  offices  of  Comptroller  of  the 
Treasury  and  Assistant  Comptroller  of  the  Treasury  are  abolished,  to  take 
effect  July  I,  1921.  All  other  officers  and  employees  of  the  office  of  the 
Comptroller  of  the  Treasury  shall  become  officers  and  employees  in  the 
General  Accounting  Office  at  their  grades  and  salaries  on  July  1 ,  192 1 ,  and 
all  books,  records,  documents,  papers,  furniture,  office  equipment  and  other 
property  of  the  office  of  the  Comptroller  of  the  Treasury  shall  become  the 
property  of  the  General  Accounting  Office.  The  Comptroller  General  is 
authorized  to  adopt  a  seal  for  the  General  Accounting  Office. 

Sec.  302,  There  shall  be  in  the  General  Accounting  Office  a  Comp- 
troller General  of  the  United  States  and  an  Assistant  Comptroller  General 
of  the  United  States,  who  shall  be  appointed  by  the  President  with  the 
advice  and  consent  of  the  Senate,  and  shall  receive  salaries  of  $10,000  and 
$7,500  a  year,  respectively.  The  Assistant  Comptroller  General  shall  per- 
form such  duties  as  may  be  assigned  to  him  by  the  Comptroller  General, 
and  during  the  absence  or  incapacity  of  the  Comptroller  General,  or  during 
a  vacancy  in  that  office,  shall  act  as  Comptroller  General. 

Sec.  303.  Except  as  hereinafter  provided  in  this  section,  the  Comp- 
troller General  and  the  Assistant  Comptroller  General  shall  hold  office  for 
fifteen  years.  The  Comptroller  General  shall  not  be  eligible  for  reappoint- 
ment. The  Comptroller  General  or  the  Assistant  Comptroller  General 
may  be  removed  at  any  time  by  joint  resolution  of  Congress  after  notice 
and  hearing,  when,  in  the  judgment  of  Congress,  the  Comptroller  General 
or  Assistant  Comptroller  General  has  become  permanently  incapacitated  or 
has  been  inefficient,  or  guilty  of  neglect  of  duty,  or  of  malfeasance  in  office, 
or  of  any  felony  or  conduct  involving  moral  turpitude,  and  for  no  other 
cause  and  in  no  other  manner  except  by  impeachment.  Any  Comptroller 
General  or  Assistant  Comptroller  General  removed  in  the  manner  herein 
provided  shall  be  ineligible  for  reappointment  to  that  office.  When  a 
Comptroller  General  or  Assistant  Comptroller  General  attains  the  age  of 
seventy  years,  he  shall  be  retired  from  his  office. 

Sec.  304.  All  powers  and  duties  now  conferred  or  imposed  by  law 
upon  the  Comptroller  of  the  Treasury  or  the  six  auditors  of  the  Treasury 
Department,  and  the  duties  of  the  Division  of  Bookkeeping  and  Warrants 
of  the  Office  of  the  Secretary  of  the  Treasury  relating  to  keeping  the  per- 


THE  BUDGET  AND  ACCOUNTING  ACT 


445 


sonal  ledger  accounts  of  disbursing  and  collecting  officers,  shall,  so  far  as 
not  inconsistent  with  this  Act,  be  vested  in  and  imposed  upon  the  General 
Accounting  Office  and  be  exercised  without  direction  from  any  other  officer. 
The  balances  certified  by  the  Comptroller  General  shall  be  final  and  con- 
clusive upon  the  executive  branch  of  the  Government.  The  revision  by 
the  Comptroller  General  of  settlements  made  by  the  six  auditors  shall  be 
discontinued,  except  as  to  settlements  made  before  July  I,  1 921. 

The  administrative  examination  of  the  accounts  and  vouchers  of  the 
Postal  Ser\  ice  now  imposed  by  law  upon  the  Auditor  for  the  Post  Office 
Department  shall  be  performed  on  and  after  July  I,  192 1,  by  a  bureau  in 
the  Post  Office  Department  to  be  known  as  the  Bureau  of  Accounts,  which 
is  hereby  established  for  that  purpose.  The  Bureau  of  Accounts  shall  be 
under  the  direction  of  a  Comptroller,  who  shall  be  appointed  by  the  Presi- 
dent with  the  advice  and  consent  of  the  Senate,  and  shall  recei\  e  a  salary  of 
$5,000  a  year.  The  Comptroller  shall  perform  the  administrative  duties 
now  performed  by  the  Auditor  for  the  Post  Office  Department  and  such 
other  duties  in  relation  thereto  as  the  Postmaster  General  may  direct.  The 
appropriation  of  $5,000  for  the  salary  of  the  Auditor  for  the  Post  Office 
Department  for  the  fiscal  year  1922  is  transferred  and  made  available  for 
the  salary  of  the  Comptroller,  Bureau  of  Accounts,  Post  Office  Department. 
The  officers  and  employees  of  the  Office  of  the  Auditor  for  the  Post  Office 
Department  engaged  in  the  administrative  examination  of  accounts  shall 
become  officers  and  employees  of  the  Bureau  of  Accounts  at  their  grades  and 
salaries  on  July  I,  1921.  The  appropriations  for  salaries  and  for  contingent 
and  miscellaneous  expenses  and  tabulating  equipment  for  such  office  for 
the  fiscal  year  1922,  and  all  books,  records,  documents,  papers,  furniture, 
office  equipment,  and  other  projjerty  shall  be  apportioned  between,  trans- 
ferred to,  and  made  available  for  the  Bureau  of  Accounts  and  the  General 
Accounting  Office,  respectively,  on  the  basis  of  duties  transferred. 

Sec.  305.  Section  236  of  the  Revised  Statutes  is  amended  to  read  as 
follows: 

"Sec.  236.  All  claims  and  demands  whatever  by  the  Government  of 
the  United  States  or  against  it,  and  all  accounts  whatever  in  which  the 
Government  of  the  United  States  is  concerned,  either  as  debtor  or  creditor, 
shall  be  settled  and  adjusted  in  the  General  Accounting  Office." 

Sec.  306.  All  laws  relating  generally  to  the  administration  of  the  de- 
partments and  establishments  shall,  so  far  as  applicable,  govern  the  General 
Accounting  Office.  Copies  of  any  books,  records,  papers,  or  documents, 
and  transcripts  from  the  books  and  proceedings  of  the  General  Accounting 
Office,  when  certified  by  the  Comptroller  General  or  the  Assistant  Comp- 


446 


APPENDIX 


troUer  General  under  its  seal,  shall  be  admitted  as  evidence  with  the  same 
effect  as  the  copies  and  transcripts  referred  to  in  sections  882  and  886  of  the 
Revised  Statutes. 

Sec.  307.  The  Comptroller  General  may  provide  for  the  payment  of 
accounts  or  claims  adjusted  and  settled  in  the  General  Accounting  Office, 
through  disbursing  officers  of  the  several  departments  and  establishments, 
instead  of  by  warrant. 

Sec.  308.  The  duties  now  appertaining  to  the  Division  of  Public 
Moneys  of  the  Office  of  the  Secretary  of  the  Treasury,  so  far  as  they  relate 
to  the  covering  of  revenues  and  repayments  into  the  Treasury,  the  issue  of 
duplicate  checks  and  warrants,  and  the  certification  of  outstanding  lia- 
bilities for  payment,  shall  be  performed  by  the  Division  of  Bookkeeping 
and  Warrants  of  the  Office  of  the  Secretary  of  the  Treasury. 

Sec.  309.  The  Comptroller  General  shall  prescribe  the  forms,  sys- 
tems, and  procedure  for  administrative  appropriation  and  fund  accounting 
in  the  several  departments  and  establishments,  and  for  the  administrative 
examination  of  fiscal  officers'  accountsand  claims  against  the  United  States. 

Sec.  310.  The  offices  of  the  six  auditors  shall  be  abolished,  to  take 
effect  July  I,  1921.  All  other  officers  and  employees  of  these  offices  except 
as  otherwise  provided  herein  shall  become  officers  and  employees  of  the 
General  Accounting  Office  at  their  grades  and  salaries  on  July  I,  1 921.  All 
books,  records,  documents,  papers,  furniture,  office  equipment,  and  other 
property  of  these  offices,  and  of  the  Division  of  Bookkeeping  and  War- 
rants, so  far  as  they  relate  to  the  work  of  such  division  transferred  by  sec- 
tion 304,  shall  become  the  property  of  the  General  Accounting  Office.  The 
General  Accounting  Office  shall  occupy  temporarily  the  rooms  now  occu- 
pied by  the  office  of  the  Comptroller  of  the  Treasury  and  the  six  auditors. 

Sec.  311.  (a)  The  Comptroller  General  shall  appoint,  remove, 
and  fix  the  compensation  of  such  attorneys  and  other  employees  in  the 
General  Accounting  Office  as  may  from  time  to  time  be  provided  for  by 
law. 

(b)  All  such  appointments,  except  to  positions  carrying  a  salary  at  a 
rate  of  more  than  $5,000  a  year,  shall  be  made  in  accordance  with  the  civil- 
service  laws  and  regulations. 

(c)  No  person  appointed  by  the  Comptroller  General  shall  be  i)aid  a 
salary  at  a  rate  of  more  than  $6,000  a  year,  and  not  more  than  four  persons 
shall  be  paid  a  salary  at  a  rate  of  more  than  $5,000  a  year. 

(d)  All  officers  and  employees  of  the  General  Accounting  Office, 
whether  transferred  thereto  or  appointed  by  the  Comptroller  General, 
shall  perform  such  duties  as  may  be  assigned  to  them  by  him. 


THE  BUDGET  AND  ACCOUNTING  ACT 


447 


(e)  All  official  acts  performed  by  such  officers  or  employees  specially 
designated  therefor  by  the  Comptroller  General  shall  have  the  same  force 
and  effect  as  though  performed  by  the  Comptroller  General  in  person. 

(f)  The  Comptroller  General  shall  make  such  rules  and  regulations  as 
may  be  necessary  for  carrying  on  the  work  of  the  General  Accounting 
Office,  including  rules  and  regulations  concerning  the  admission  of 
attorneys  to  practice  before  such  office. 

Sec.  312.  (a)  The  Comptroller  General  shall  investigate,  at  the  seat 
of  government  or  elsewhere,  all  matters  relating  to  the  receipt,  disburse- 
ment, and  application  of  public  funds,  and  shall  make  to  the  President 
when  requested  by  him,  and  to  Congress  at  the  beginning  of  each  regular 
session,  a  report  in  writing  of  the  work  of  the  General  Accounting  Office, 
containing  recommendations  concerning  the  legislation  he  may  deem  neces- 
sary to  facilitate  the  prompt  and  accurate  rendition  and  settlement  of  ac- 
counts and  concerning  such  other  matters  relating  to  the  receipt,  disburse- 
ment, and  application  of  public  funds  as  he  may  think  advisable.  In  such 
regular  report,  or  in  special  reports  at  any  time  when  Congress  is  in  session, 
he  shall  make  recommendations  looking  to  greater  economy  or  efficiency  in 
public  expenditures. 

(b)  He  shall  make  such  investigations  and  reports  as  shall  be  ordered 
by  either  House  of  Congress  or  by  any  committee  of  either  House  having 
jurisdiction  over  re\enue,  appropriations,  or  expenditures.  The  Comp- 
troller General  shall  also,  at  the  request  of  any  such  committee,  direct 
assistants  from  his  office  to  furnish  the  committee  such  aid  and  informa- 
tion as  it  may  request. 

(c)  The  Comptroller  General  shall  specially  report  to  Congress  every 
expenditure  or  contract  made  by  any  department  or  establishment  in  any 
year  in  violation  of  law. 

(d)  He  shall  submit  to  Congress  reports  upon  the  adequacy  and  effec- 
tiveness of  the  administrative  examination  of  accounts  and  claims  in  the 
respective  departments  and  establishments  and  upon  the  adequacy  and 
effectiveness  of  departmental  inspection  of  the  offices  and  accounts  of  fiscal 
officers. 

(e)  He  shall  furnish  such  infonnation  relating  to  expenditures  and  ac- 
counting to  the  Bureau  of  the  Budget  as  it  may  request  from  time  to 
time. 

Sec.  313.  All  departments  and  establishments  shall  furnish  to  the 
Comptroller  General  such  information  regarding  the  powers,  duties,  activi- 
ties, organization,  financial  transactions,  and  methods  of  business  of  their 
respective  offices  as  he  may  from  time  to  time  require  of  them;  and  the 


448 


APPENDIX 


Comptroller  General,  or  any  of  his  assistants  or  employees,  when  duly  au- 
thorized by  him,  shall,  for  the  purpose  of  securing  such  information,  have 
access  to  and  the  right  to  examine  any  books,  documents,  papers,  or  records 
of  any  such  department  or  establishment.  The  authority  contained  in  this 
section  shall  not  be  applicable  to  expenditures  made  under  the  provisions 
of  section  291  of  the  Revised  Statutes. 

Sec.  314.  The  Civil  Service  Commission  shall  establish  an  eligible 
register  for  accountants  for  the  General  Accounting  Ofifice,  and  the  exami- 
nations of  applicants  for  entrance  upon  such  register  shall  be  based  upon 
questions  approved  by  the  Comptroller  General. 

Sec.  315.  (a)  All  appropriations  for  the  fiscal  year  ending  June  30, 
1922,  for  the  offices  of  the  Comptroller  of  the  Treasury  and  the  six  auditors, 
are  transferred  to  and  made  available  for  the  General  Accounting  Office, 
except  as  otherwise  provided  herein. 

(b)  During  such  fiscal  year  the  Comptroller  General,  within  the  limit 
of  the  total  appropriations  a\'ailable  for  the  General  Accounting  Office,  may 
make  such  changes  in  the  number  and  compensation  of  officers  and  em- 
ployees appointed  by  him  or  transferred  to  the  General  Accounting  Office 
under  this  Act  as  may  be  necessary. 

(c)  There  shall  also  be  transferred  to  the  General  Accounting  Office 
such  portions  of  the  appropriations  for  rent  and  contingent  and  miscella- 
neous expenses,  including  allotments  for  printing  and  binding,  made  for  the 
Treasury  Department  for  the  fiscal  year  ending  June  30,  1922,  as  are  equal 
to  the  amounts  expended  from  similar  appropriations  during  the  fiscal 
year  ending  June  30,  1921,  by  the  Treasury  Department  for  the  offices  of 
the  Comptroller  of  the  Treasury  and  the  six  auditors. 

(d)  During  the  fiscal  year  ending  June  30,  1922,  the  appropriations  and 
portions  of  appropriations  referred  to  in  this  section  shall  be  available  for 
salaries  and  expenses  of  the  General  Accounting  Office,  including  payment 
for  rent  in  the  District  of  Columbia,  traveling  expenses,  the  purchase  and 
exchange  of  law  books,  books  of  reference,  and  for  all  necessary  miscella- 
neous and  contingent  expenses. 

Sec.  316.  The  General  Accounting  Office  and  the  Bureau  of  Accounts 
shall  not  be  construed  to  be  a  bureau  or  office  created  since  January  1,1916, 
so  as  to  deprive  employees  therein  of  the  additional  compensation  allowed 
civilian  employees  under  the  provisions  of  section  6  of  the  Legislative, 
Executive,  and  Judicial  Appropriation  Act  for  the  fiscal  year  ending  June 
30,  1922,  if  otherwise  entitled  thereto. 

Sec.  317.  The  provisions  of  law  prohibiting  the  transfer  of  employees 
of  executive  departments  and  independent  establishments  until  after  serv- 


THE  BUDGET  AND  ACCOUNTING  ACT 


449 


ice  of  three  years  shall  not  apply  during  the  fiscal  year  ending  June  30, 
1922,  to  the  transfer  of  employees  to  the  General  Accounting  Office. 

Sec.  318.  This  Act  shall  take  effect  upon  its  approval  by  the  Presi- 
dent: Provided,  That  sections  301  to  317,  inclusive,  relating  to  the  General 
Accounting  Office  and  the  Bureau  of  Accounts,  shall  take  effect  July  1, 
1921. 

Approved,  June  10,  1921. 


29 


APPENDIX  B 


ADMINISTRATIVE  CODE  FOR  THE  STATE 
OF  OHIO 

Department  of  Finance 

Sec.  154-28.  The  department  of  finance  shall  have  power  to  exercise 
control  over  the  financial  transactions  of  all  departments,  offices  and  insti- 
tutions, except  the  judicial  and  legislative  departments,  as  follows: 

(1)  By  prescribing  and  requiring  the  installation  of  a  uniform  system  of 
accounting  and  reporting,  as  to  accruals  of  revenue  and  expenditures  neces- 
sary in  certifying  that  funds  are  available  and  adequate  to  meet  contracts 
and  obligations. 

(2)  By  prescribing  and  requiring  uniform  order  and  invoice  forms  and 
forms  for  financial  reports  and  statements,  and  by  requiring  financial  re- 
ports and  statements. 

(3)  By  requiring  itemized  statements  of  expenditures  proposed  for  any 
specified  future  period  to  be  submitted  to  the  department,  and  by  approv- 
ing or  disapproving  all  or  any  part  of  such  proposed  expenditures. 

(4)  By  requiring  orders,  invoices,  claims,  vouchers  or  payrolls  to  be 
submitted  to  the  department,  where  such  submission  is  prescribed  by  law 
or  where  the  governor  shall  deem  such  submission  necessary,  and  by  ap- 
proving or  disapproving  such  orders,  invoices,  claims,  vouchers  or  payrolls. 

(5)  By  supervising  and  examining  accounts,  the  expenditures  and  re- 
ceipts of  public  money  and  the  disposition  and  use  of  public  property,  in 
connection  with  the  administration  of  the  state  budget. 

(6)  By  prescribing  the  manner  of  certifying  that  funds  are  available 
and  adequate  to  meet  contracts  and  obligations. 

(7)  By  prescribing  uniform  rules  governing  forms  of  specifications, 
advertisements  for  proposals,  opening  of  bids,  making  of  awards  and  con- 
tracts, governing  purchases  of  supplies  and  performance  of  work. 

(8)  By  reporting  to  the  attorney  general  for  such  action,  civil  or  crimi- 
nal, as  the  attorney  general  may  deem  necessary  all  facts  showing  illegal 
expenditures  of  the  public  money  or  misappropriation  of  public  property. 

(9)  By  prescribing  rules  and  regulations  for  carrying  into  efi'ect  any  or 
all  of  the  other  powers  herein  granted. 

450 


ADMINISTRATIVE  CODE  FOR  OHIO 


No  provision  of  law  authorizing  or  requiring  any  department,  office,  or 
institution  to  keep  accrual,  encumbrance  or  cost  accounts  or  to  exercise  fiscal 
management  and  control  over  or  with  respect  to  any  institution,  activity 
or  function  of  the  state  shall  be  so  construed  as  to  exclude  such  department, 
office  or  institution  from  the  control  of  the  department  of  finance  herein 
specified,  but  the  power  of  the  department  of  finance  herein  provided  for 
shall  apply  and  relate  to  such  accounts  and  reports  of  all  such  departments, 
offices  and  institutions. 

Sec.  154-29.    As  used  in  section  154-28  of  the  General  Code: 

"Order"  means  a  copy  of  a  contract  or  a  statement  of  the  nature  of  a 
contemplated  expenditure,  a  description  of  the  property  or  commodity  to 
be  purchased  or  service  to  be  performed,  other  than  services  of  officers 
and  regular  employes  of  the  state,  and  per  diem  of  the  national  guard,  and 
the  total  sum  of  the  expenditures  to  be  made  therefor  if  the  same  is  fixed 
and  ascertained,  otherwise  the  estimated  sum  thereof. 

"Invoice"  means  and  includes  estimates  or  contracts,  or  a  statement 
showing  deli\'ery  of  the  commodity  or  performance  of  the  service  described 
in  the  order,  and  the  date  of  the  purchase  or  rendering  of  the  service,  or  a 
detailed  statement  of  the  things  done,  material  supplied  or  labor  furnished, 
and  the  sum  due  pursuant  to  the  contract  or  obligation. 

"Voucher"  means  the  order  and  invoice  as  herein  defined ;  and  where- 
ever  in  the  General  Code  the  word  "voucher"  is  used  it  shall  be  held  to 
have  the  meaning  herein  defined. 

"  Public  money  "  shall  have  the  meaning  defined  in  section  two  hundred 
and  eighty-six  of  the  General  Code. 

All  orders  and  invoices  shall  specify  the  appropriation  account  from 
which  they  are  payable. 

Sec.  154-30.  If  any  requirement  of  the  department  of  finance  re- 
specting the  submission  of  statements  of  proposed  expenditures,  or  orders, 
invoices,  claims,  vouchers  or  payrolls  is  not  complied  with,  or  if  any  state- 
ment of  proposed  expenditures,  or  any  order,  in\  oice,  claim,  voucher  or 
payroll  is  submitted  to  and  disapproved  in  whole  or  in  part  by  the  depart- 
ment of  finance,  the  department  shall  have  authority  to  notify  the  auditor 
of  state  thereof,  and  such  auditor  shall  not  issue  any  warrants  on  the 
treasury  in  pa>'mcnt  of  such  expenditure,  claim  or  voucher. 

The  department  of  finance  may  certify  to  the  auditor  of  state  any  order 
or  statement  of  proposed  expenditures  approved  by  it,  and  direct  the  proper 
appropriation  account  or  accounts  to  be  charged  therewith,  or  with  the 
estimated  amount  thereof,  in  which  event  the  sum  so  certified  shall  be  a 
prior  charge  on  such  appropriation  account  or  accounts,  available  only  for 


452 


APPENDIX 


the  payment  of  invoices  issued  against  such  order,  or  expenditures  within 
such  statement,  until  the  final  invoice  therefor  is  filed  with  the  auditor  of 
state,  or  until  the  department  of  finance  shall  certify  that  such  order  and 
the  obligation  recited  therein  have  ceased  to  be  an  obligation  against  the 
state,  or  such  proposed  expenditures  have  been  made  or  abandoned  in  whole 
or  in  part. 

Whenever  any  commodity  or  service  included  in  such  order  or  statement 
so  certified  is  deli\'ered  or  performed,  or  whenever  any  payment  is  due  upon 
any  contract  or  obligation  covered  thereby,  an  invoice  shall  be  filed  with 
the  auditor  of  state  therefor.  The  total  of  all  invoices  issued  against  any 
such  order  shall  not  exceed  the  sum  of  such  order  or  the  estimated  sum 
appearing  on  such  order. 

Sec.  154-31.    The  department  of  finance  shall : 

(1)  Prepare  and  report  to  the  governor,  when  requested,  estimates  of 
the  income  and  revenues  of  the  state,  and  devise  new  forms  of  revenue  for 
the  state; 

(2)  Prepare  and  submit  to  the  governor  biennially,  not  later  than  the 
first  day  of  January  preceding  the  convening  of  the  general  assembly,  state 
budget  estimates; 

(3)  Publish,  from  time  to  time,  for  the  information  of  the  several  de- 
partments and  of  the  general  public,  bulletins  of  the  work  of  the  depart- 
ment; 

(4)  Investigate  duplication  of  work  of  the  departments  and  the  effi- 
ciency of  the  organization  and  administration  of  departments,  and  formu- 
late plans  for  the  further  coordination  of  departments. 

Sec.  1 54-32.  In  the  exercise  of  any  of  the  powers  mentioned  in  section 
154-28  of  the  General  Code,  the  department  of  finance  shall  have  the  power 
to  compel  the  attendance  and  testimony  of  witnesses,  to  administer  oaths 
and  to  examine  such  persons  as  it  may  deem  necessary,  and  compel  the 
production  of  books  and  papers.  The  orders  and  subpoenas  issued  by  the 
department  in  pursuance  of  the  authority  in  it  vested  by  this  section  may 
be  enforced,  on  the  application  of  the  director  of  finance,  by  any  court  of 
common  pleas  by  proceedings  in  contempt  therein  as  provided  by  law. 

Sec.  154-33.  the  preparation  of  state  budget  estimates  the  direc- 
tor of  finance  shall,  not  later  than  the  fifteenth  day  of  September  in  the 
year  preceding  the  regular  session  of  the  general  assembly,  distribute  to  all 
departments,  offices  and  institutions  of  the  state  government,  the  blanks 
necessary  for  the  preparation  of  budget  estimates,  which  shall  be  in  such 
form  as  shall  be  prescribed  by  the  director  of  finance,  to  procure,  among 
other  things,  information  as  to  the  revenues  and  expenditures  for  the  two 


ADMINISTRATIVE  CODE  FOR  OHIO 


453 


preceding  fiscal  years,  and  appropriations  made  by  the  previous  general 
assembly,  the  expenditures  therefrom,  encumbrances  thereon,  and  the 
amounts  unencumbered  and  unexpended ;  an  estimate  of  the  revenues  and 
expenditures  of  the  current  fiscal  year,  and  an  estimate  of  the  revenues  and 
amounts  needed  for  the  respective  departments,  offices,  and  institutions 
for  the  two  succeeding  fiscal  years  for  w  hich  appropriations  have  to  be 
made.  Each  department,  ofifice  and  institution  shall,  not  later  than  the 
first  day  of  November,  file  in  the  ofifice  of  the  director  of  finance  its  esti- 
mate of  receipts  and  expenditures  for  the  succeeding  biennium.  Such 
estimate  shall  be  accompanied  by  a  statement  in  writing  giving  facts  and 
explanations  of  reasons  for  each  item  of  exj^enditure  requested.  The 
director  of  finance  may  in  his  discretion  make  further  inquiry  and  in- 
vestigation as  to  any  itein  desired.  He  may  approve,  disapprove  or  alter 
the  estimates,  excepting  those  for  the  legislative  and  judicial  departments 
of  the  state  government.  Such  estimates  as  revised  by  him  shall  con- 
stitute the  state  budget  estimates  which  the  department  of  finance  is 
required  by  this  chapter  to  submit  to  the  governor. 

Sec.  154-34.  The  governor  shall,  as  soon  as  possible  and  not  later  than 
four  weeks  after  the  organization  of  the  general  assembly,  submit  a  pro- 
posed state  budget  in  the  form  of  an  appropriation  bill  or  bills  and  a  state- 
ment showing  the  amounts  recommended  by  him  to  be  appropriated  to  the 
respective  departments,  offices  and  institutions  and  for  all  other  public  pur- 
poses, the  estimated  revenues  from  taxation,  the  estimated  revenues  from 
sources  other  than  taxation,  and  an  estimate  of  the  amount  required  to  be 
raised  by  taxation. 

Sec.  154-35.  Each  department,  office  and  institution  of  the  state 
government,  other  than  the  legislative  and  judicial  departments  thereof, 
shall,  before  any  appropriation  to  such  department  becomes  available  for 
expenditure,  prepare  and  submit  to  the  department  of  finance  an  estimate 
of  the  amount  required  for  each  specific  purpose  within  the  appropriation, 
or  items  of  appropriation,  as  made  by  the  general  assembly,  and  accounts 
shall  be  kept  and  reports  rendered  to  the  department  of  finance  showing 
the  expenditure  for  each  such  purpose.  The  department  of  finance  shall 
exercise  such  control  over  items  of  appropriation  accounts  created  by  the 
general  assembly,  with  respect  to  changes  and  adjustments  therein  within 
the  general  scope  of  a  specific  appropriation,  as  may  be  committed  to  it  by 
any  act  making  appropriations,  and  shall  in  general  exercise  such  control 
over  the  expenditure  of  appropriations,  in  addition  to  that  specifically  pro- 
vided for  in  this  chapter,  as  may  be  so  committed  to  it. 

Sec.  154-36.    The  papers,  statements  and  copies  thereof  required  by 


454 


APPENDIX 


section  270-6  of  the  General  Code  to  be  filed  in  the  ofiice  of  the  president  of 
the  "Sundry  Claims  Board"  therein  provided  for  shall  be  hereafter  de- 
livered to  and  filed  in  the  office  of  the  department  of  finance,  and  such  de- 
partment shall  discharge  all  the  duties  provided  for  in  said  section  of  the 
General  Code  with  respect  to  the  filing,  delivery  and  preservation  of  such 
papers,  statements  and  copies  thereof.  The  director  of  finance  shall  in- 
clude all  claims  allowed  by  the  "Sundry  Claims  Board  "in  the  state  budget 
estimates. 

Sec.  154-37,  The  department  of  finance  shall  succeed  to  and  exercise 
all  powers  and  perform  all  duties  vested  by  sections  one  thousand  eight 
hundred  and  forty-six  and  one  thousand  eight  hundred  and  forty-seven  of 
the  General  Code  jointly  in  the  secretary  of  state  and  the  auditor  of  state, 
which  said  powers  are  hereby  transferred  to  and  vested  in  said  department. 

The  department  of  finance  shall  succeed  to  and  exercise  all  powers  of  the 
state  purchasing  agent  in  the  office  of  the  secretary  of  state,  and  the  secre- 
tary of  state  and  auditor  of  state  with  respect  to  the  purchase  of  supplies 
and  equipment  required  for  the  use  and  maintenance  of  state  officers, 
boards  and  commissions,  the  commissioners  of  public  printing  and  the 
supervisor  of  public  printing,  and  shall  exercise  all  powers  and  perform  all 
duties  as  to  purchases  heretofore  vested  in  the  Ohio  board  of  administra- 
tion under  the  provisions  of  section  one  thousand  eight  hundred  and  forty- 
nine  of  the  General  Code.  Wherever  powers  are  conferred  or  duties  im- 
posed upon  any  such  departments,  ofiices  or  officers  with  respect  to  the 
matters  and  things  herein  mentioned,  such  powers  and  duties  shall  be  con- 
strued as  vested  in  the  department  of  finance.  In  addition  to  the  powers  so 
transferred  to  it,  the  department  of  finance  shall  have  power  to  purchase 
all  other  supplies,  material  and  equipment  for  the  use  of  the  state  depart- 
ments, offices  and  institutions,  excepting  the  military  department  and  in- 
stitutions, administered  by  boards  of  trustees,  and,  excepting  as  to  such 
department  and  institutions,  to  make  contracts  for  and  superintend  the 
telephone  and  telegraph  service  for  the  state  departments,  ofiices  and  in- 
stitutions. So  far  as  practicable,  the  department  of  finance  shall  make  all 
purchases  under  authority  of  this  chapter  from  the  department  of  public 
welfare  in  the  exercise  of  the  functions  of  said  department  in  the  manage- 
ment of  state  institutions. 

Sec.  1 54-38.  The  tax  commission  of  Ohio  shall  be  a  part  of  the  depart- 
ment of  finance  for  administrative  purposes,  in  the  following  respects:  The 
director  of  finance  shall  be  ex  officio  the  secretary  of  said  commission,  shall 
succeed  to  and  perfonri  all  of  the  duties  of  the  secretary  of  said  commission, 
and  shall  exercise  ail  powers  of  said  secretary  as  provided  by  law;  but  such 


ADMINISTRATIVE  CODE  FOR  OHIO 


455 


director  may  designate  any  employe  of  the  department  as  acting  secretary 
to  perform  the  duties  and  exercise  the  powers  of  secretary  of  the  commis- 
sion. All  clerical  and  other  agencies  for  the  execution  of  the  powers  and 
duties  vested  in  said  tax  commission  of  Ohio  shall  be  deemed  to  be  in  the 
department  of  finance,  and  the  employes  thereof  shall  be  deemed  to  be 
employes  in  said  department  and  shall  have  and  exercise  all  authority 
vested  by  law  in  the  employes  of  such  commission.  But  the  tax  com- 
mission of  Ohio  shall  have  direct  supervision  and  control  over,  and  power  of 
appointment  and  removal  of,  such  employes  whose  positions  shall  be  desig- 
nated by  the  governor  as  fully  subject  to  the  authority  of  such  commission. 


APPENDIX  C 


A  TRUST  COMPANY  BUDGET  SYSTEM 

By  Stuart  H.  Patterson,  Comptroller  of  the 
Guaranty  Trust  Company  of  New  York 

The  Guaranty  Trust  Company  has  received  a  number  of  requests  for  an 
explanation  of  its  budget  system  for  expenses.  Thinking  that  possibly 
other  of  its  correspondents  might  desire  to  utilize  this  method,  the  following 
brief  description  of  the  system  has  been  prepared. 

The  first  step  in  this  matter  is  to  make  a  careful  classification  of  the  va- 
rious expenses,  so  that  it  will  be  possible  to  locate  readily  any  differences 
between  the  budget  allowance  and  the  actual  expenditures.  The  second 
step  is  to  estimate  carefully  the  probable  expenditure  under  each  classifi- 
cation, by  months,  for  the  coming  year;  and  after  the  estimates  have  been 
duly  approved  by  the  Executive  Officers,  to  distribute  them  by  months  on 
an  Appropriation  Sheet,  the  notations  being  made  thereon  in  pencil. 

The  purpose  of  preparing  the  Appropriation  Sheet  in  pencil  is  to  permit 
changes  to  be  made  from  time  to  time  during  the  year,  either  because  of 
additional  appropriations,  or  because  some  appropriation,  say,  for  adver- 
tising, may  not  be  expended  until  a  later  month  than  was  anticipated,  and 
consequently  the  appropriation  should  be  carried  along  until  such  time  as 
the  expenditure  actually  takes  place.  The  amounts  should  be  distributed 
as  well  as  possible  o\'er  the  probable  months  the  expenditures  will  take 
place,  with  a  notation  on  the  budget  to  "carry  along"  such  item,  that  is, 
to  carry  it  along  as  an  appropriation  until  required.  As  soon  as  a  month 
is  closed,  the  appropriations  applicable  to  that  month  are  inserted  in  ink. 

Each  month  the  appropriations  are  carried  from  the  Appropriation 
Sheet  to  the  Expense  Statements,  and  entered  opposite  the  actual 
expenditures  under  each  classification. 

The  Expense  Statements  are  divided  into  a  Monthly  Statement  and  a 
Cumulative  Statement  from  January  i  to  the  end  of  the  month  just  closed. 
The  Cumulative  Statement  carries  a  memorandum  column  of  the  budget 
for  the  entire  year  for  each  classification.  With  this  arrangement  the  state= 
ment  shows  at  all  times  the  amount  each  department  or  classification  may 
spend,  and,  should  the  budget  exceed  its  limit  during  one  month,  the  lee- 
way that  exists  for  making  up  the  deficiency  i:i  some  other  month. 

456 


A  TRUST  COMPANY  BUDGET  SYSTEM 


457 


The  budget  system  is  really  very  simple,  but  it  is  efifective  in  indicating 
the  probable  expenses  for  a  year  before  the  expenditures  are  incurred,  in- 
stead of  giving  an  unsatisfactory  review  of  them  after  the  year  is  closed. 
This  system  also  promotes  economies  which  might  otherwise  be  overlooked. 

A  copy  of  the  instructions  regarding  the  1919  Budget,  which  were  sent 
to  Department  Heads,  follows: 


It  is  desired  that  the  budget  for  conducting  the  business  for  the  year  1919 
shall  be  in  the  hands  of  the  Managing  Committee  by  December  i,  191 8,  and 
the  Ofificers  in  charge  of  all  departments  are  requested  to  have  the  figures 

carefully  prepared  by  that  date  and  delivered  to  Mr.  

In  preparing  the  budget  each  department  shall  show  separately  by 
months  the  amounts  of  salaries,  suppers,  postage  and  stationery,  and  other 
items.  They  shall  also  show  the  details  which  go  to  make  up  the  "other 
items.  " 

An  illustration  of  the  budget  form  is  as  follows: 

Budget  Statement  of  Department 


1919  Budget 


FOR  Year  191 9 


Other 


Salaries 


Suppers 

$    5  00 


Postage 
$  40.00 


Stationery  Items 


January. . 
February . 
March.  .  . 

April  

May  

June  

July  

August .  .  . 
September 
October.  . 
November 
December . 


$  1,950 


$  80.00    $  35.00 

80.00  35  00 

80.00  35  00 

80.00  35  00 

80.00  35.00 

80.00  35  00 

80.00  35  00 

80.00  35  00 

80.00  35  00 

80.00  35  00 

80.00  35.00 

80.00  35.00 


1.950 
1,950 
1,950 
1,950 
1,950 
1,950 
1,950 
1,950 
1,950 
1,950 
1,950 


5.00 

10.00 
5.00 
5.00 

10.00 
5.00 
5.00 

10.00 
5.00 
5.00 

10.00 


40.00 
40.00 
50.00 
40.00 
50.00 
40.00 
40.00 
50.00 
40.00 
40.00 
50.00 


$23,400 


$  80.00 


$520.00 


$960.00  $420.00 


Detail  of  Other  Items 


Repairs  to  coin  wrapping  machine 
Rental  of  Telautograph  machines . 
Inspection  of  adding  machines.  .  . 

Photostatic  expenses  

Repairs  to  money  truck  


$  60.00 
210.00 

12 .00 
120.00 

12 .00 


$414.00 


458 


APPENDIX 


Each  department  should  keep  a  copy  of  its  budget,  and  if  during  the 
year  it  becomes  necessary  to  expend  money  for  some  item  not  included  in 
the  budget,  it  should  be  the  duty  of  the  Officer  in  charge  of  such  department 
to  see  that  an  additional  appropriation  be  granted  before  the  expenditure  is 
incurred. 

Requests  for  additional  appropriations  should  be  made  to  the  Comp- 
troller in  writing  on  the  form  prepared  for  that  purpose,  together  with  a 
memorandum  showing  why  the  additional  expense  is  necessary.  The 
Comptroller  has  authority  to  grant  such  additional  appropriations  but 
should  he  decline  to  approve  any  appropriation  either  because  he  believes 
it  to  be  unnecessary,  or  because  he  thinks  the  matter  should  have  the  atten- 
tion of  the  Officers  Meeting,  it  may  be  presented  to  the  Officers  Meeting 
through  the  Vice-President  responsible  for  the  operation  of  the  department 
making  the  request. 


A  TRUST  COMPANY  BUDGET  SYSTEM 


459 


Guaranty  Trust  Company  of  New  York         sheet  no.i 

Summary  of  Expenses  for  Month  of  192 

BALABiaa 

BUPFKR8 

ITEMS       1  nCPBNSIS 

PBXVIOUB 

TUB 

EXPENSE  OF  SECURING 
BUSINESS 

New  Boailien  DepartjneDt 

See  Sbeet  2 

Publicity  Department 

See  Sbeet  2 

Bond  DepajtmeDt 

See  Sheet  2 

Sth  Ave.  Office 

See  Sheet  6 
Madisoa  Ave.  Office 

See  Sheet  6 

1.  OScen*  Salaries 

2.  "  LuDcbes 

3.  Foreign  RepresentativeB 
i.  GenersJ  Traveling  after 

Bueinefls 
5.  General  Entertaining 
8.  Library 

7.  Income  Tu  Dept. 
8. 

g. 

EXPENSE  OP  TRANS- 
ACTING BUSINESS 

CUBRKNT  OPEBATINQ 

Main  Office        See  Sheet  3 
Sth  Ave.  Office    See  Sheet  ( 
Madifion  Ave.  Office 

See  Sbeet 6 

FixxD  8T  Policy 
Main  Office        See  Sbeet  3 
6tb  Ave.  Office    See  Sbeet  6 
Madison  Ave.  Office 

See  Sbeet  6 

Main  Office  -      See  Sheet  4 
6lb  Ave.  Office    See  Sheet  6 
Maduoo  Ave.  Office 

Bee  Sheet  8 

310.  Officers'  Salariea 

311.  "  Lunchee 

NoN  Proddctiv*  ExpKNera 
Main  Office        See  Sheet  4 
Sth  Ave.  Office    See  Sheet  6 
Madison  Ave.  Office 

See  Sheet  e 

TOTAL  EXPENSES 

1 

_ 

1 

1 

_ 

_ 

1 

1 

1    1  1 

1  1 

BEMAKK3 

APPENDIX 


SHEET  No.  a 

Expenses  of  Securing  Business     Month  of  192 

BAUBIXa 

BUPPKRfl 

POBTAOC  aNV 
aTATIONSRT 

omB 

TOTAL 
■XPSNStS 

APPBO- 
PBUTIOKS 

PRBTI0U8 
UONIB 

SAHIUOIta 
LASTTIAl 

NEW  BUSINESS 

30.  Salnria 

31.  Additioul  Wu  Com- 

peiuattOD 

32.  8upprri 

33.  Sutiooery  &  Supplies 

34.  Poetsge 

Si.  TraveTmgEipenaeeN.Y. 
Men 

39.  Telegram!  i  TelepboDe 
Tolls 

37.  EntertaiDmeot 

38.  Other  Eipeosa 
Out  of  Town  Men 

39.  Siluiei 

40.  Rent 

41.  ExpenBOB 

42.  Tnveltng 
43. 

44. 
«». 

Tottl 

PUBLICITY 
60.  Salaries 

ei.  Additional  War  Com- 
pensation 

62.  Suppers 

63.  Stationery  A  Supplies 

64.  Postaie 

65.  Traveling  Expenses 
69.  Printing  4  Circulars 
67.  Telegrams  i  Telephone 

Tolls 
6S.  Entertainment 

69.  Other  Expenses 

70.  Advertising  in  Publics. 

tions 

71.  General  Advertising  i' 

Publicity 

72. 
73. 
74. 

ToUl 

BOND  DEPARTMENT 

100.  Trading  Div, 

101.  Distributing  Dir. 

102.  City  Salesmen 

103.  Outside  Dealers 

104.  Municipal  Div. 
103.  Special  Salaj  Div, 

106.  Cforreepondence  Div. 

107.  Executive  Secretaries 
103.  Corporation  &  New  Busi- 
ness Div. 

109.  Administration 

Accounting,  ic. 

110.  Undistributed  Salaries 
111. 

112, 

113.  Statistical 

114.  Investigation  Div. 

115.  Outside  Investigations 

&  Examinations 
U9.  Out  of  Town  Offices- 
Rent 
117-  Salaries 
113.     Private  Wires 

119.  Traveling 

120.  Expenses 
121. 

122. 
123- 

124.  Buppets 

125.  Aclditionsl  War  Com- 

pensation 
129.  Telephone  Tolb— Tele- 
grams &  Cables 
127.  Stationery  i  Supplies 
123.  Circulars  i  Printed 
Matter 

129.  Postage 

130.  Traveling  Expenses 

131.  Entertainment 

132.  Advertising 

133.  Stock  Ticker 
134. 

135. 
136. 
137. 
138. 

Total 

- 

A  TRUST  COMPANY  BUDGET  SYSTEM 


SHEET  No.3 

Expenses  of  Transacting  Business — Main  Office      Month  of  192 

sumu 

roBuoB  un 
maTtomBT 

iTnu 

TOTAL 

AFPKO- 

Ptunoita 

MOIfTB 

L&ST  TUB 

CUERENT  OPERATING 
Dmpartkint 

160.  AccouBting 

161.  AcalyBis 

162.  Aaditing 

163.  Aithivefl 

164.  BooUfepiog 

165.  Collection 

166.  Tellere 

167.  CoupOD 
108.  Citdit 

16».  Chief  Clerk's 

170.  Emergency 

171.  General  Fages 

172.  Filing 

173.  Load 

174.  Muling 

175.  MeasengeTB 

176.  Reorganisation 

177.  Regiatration 

178.  Securities 

179.  Stenographers— General 

180.  Secrctariee — Executive 

181.  Supply  Dept  Operating 

182.  Special  Officen  and 

Watchmen 

183.  Stock  Bookkeeping 

184.  Transfer 

TelepI  one.  Telegraph  & 
Cable 

185.  Salaries  Operators 

186.  Service 

187.  Uadistribuleii  ToUi 

188.  Trust 

189.  Vault 

190.  Eiprwage  t  MaJ  In- 
Foreign  Department 

191.  SlUaria 

192.  Suppers 

193.  Travel 

194.  Telegrams.  Cables  & 

Tel.  Calls 

195.  Postage  i  Express 

196.  Stationery  &  Supplia 

197.  Sundries 
198. 

199. 

2oa 

201. 
203. 
203. 
Ml 
MS. 

tot. 

^■ 
M8. 
90». 

no. 
an. 
ai2. 

313. 
214. 
2li. 

Total 

TtXSD  BT  POUCT 

230.  Resident  Attorney 

231.  Legal  i  Professional  Fe« 

232.  Directora  it  Committee 

Fees  . 

233.  Examinations  &  Eleo- 

231.  Insurance   Liability  & 
Fire 

235.  Fidelity  Bonds 
336.  Dining  Room 
237.  Cuslomera'  Check  Books 
free 

238. 
239. 
340. 
341. 
242. 
MS. 
344. 
Itt. 

Total 

1  1 

APPENDIX 


;                                                                                                              SHEET  No.  4 
Expenses  of  Transacting  Business — Main  OflBce  (Continued)     Month  of  192 

BALiRlxa 

POSTAOl  Aim 
BTATIOmBT 

BXPENSXS 

APPRO 

PRUT10K8 

PREVIOUB    jsAUE  UOKTH 

Rent— 140  Broadway 
■!C0.  Salaries 

201.  Elcc.  Currmt 

202.  Steam 

263.      Materials  t  Repain 

204.  Ta<e9,  Real  Estate 

205.  Water 

266.  Burglar  Alans 

267.  Other  Itemj 

268.  Postage  i  SlatioDery 
269. 

270.  Rents  Reeeivcd 

271.  Other  N.  Y.  Rentals 

272.  Stock  4  News  Tickers 
27.1.  Drioking  Water  4  Ice 

274.  LauDtlry  4  Towels 

275.  Clearing  House  4  Fed 

Reserve  Charges 

276.  N.  Y.  4  Other  Banking 

Dept.  Fees 

277.  Furniture  and  Fiittires 

Repairs 
Undistributed  Items; 

278.  Stationery  4  Books 
278.   Supplies  Other  Than 

Stationery 

280.  Postage 

281.  Suppers 

282.  Traveling  Incident  to 

Current  Business 

283.  Loss  on  Obsolete  SU- 

284.  Generaf 

285.  Ne»  Furniture.  Fijtures 

4  Et^uipmejit 

286.  AJttretlOW 
287. 

288. 
28». 
290. 
291. 
292. 
293. 
294. 
295. 
296. 
297. 
298. 
299. 
300. 
301. 
302. 
303. 
304. 

Tout 

TOTAL  TRANSACTINO 

BUSINESS 

NON  PRODUCTIVE 
EXPENSES 
390.  OSoeraACIerksonWar 
Duty 

321.  Pensions  4  DooatioQS  to 

Employees 

322.  Educational 

323.  Guaranty  Club 

324.  Subscriptions.  Dues,  etc. 

325.  Wellars  Dept. 

326.  Medical  Supplies  i  Ei- 

aminations 

327.  Liberty  Loan  Expeoses 

328.  Additional  Compensa- 

tion a/0  War 

329. 
330. 
331. 
332. 
333. 
334. 
335. 
336. 
337. 
338. 
339. 
340. 

Total 

A  TRUST  COMPANY  BUDGET  SYSTEM 


Guaranty  Trust  Company  of  New  York  ' 

Summary  of  Expenses  for  January  1st  to  192 

auvpiu 

POBTAOX  iI40 

nrau 

TOTAL 

APPRO- 
KUATIOHB 

pBunom 

rOB  TBAB 

auanuoD 

LUTTBU 

BXPENSK  OP  SECDTUNO 

BUSINESS 
Nt*  BonnoB  I)«partiBeDt 

Boe  Shnt  8 
PublnttT  Dmutmcnt 

8«eSh«t8 
Bond  DciMitTMnt 

ewSkectS 

Stb  At*.  OfBea 

SeeShtet  11 
MadiaoD  Ara.  Offiea 

Sw  Stmt  12 

1.  OtBcn' Sslviet 

2.  "  LuDchra 

3.  Foreign  Repree<ntsttT«i 

4.  Oeoeral  TrsTeling  after 

Business 
8.  OeDcnl  EDtertainiog 
0.  Library 

7.  Inooms  Tax  DepL 

a! 

EXPENSE  OF  TRANS 

ACTING  BUSINESS 

CdBRINT  OriRATINd 

Main  Office        See  Sbeet  9 
Sth  Are.  OlBcs  Se«  Sheet  11 
MadisoD  Are.  Office 

See  Sheet  12 

Fnrio  BT  PoLicr 
Main  Office        See  Sheet  t 
Sth  Ave.  Office  See  Sheet  11 
Madison  Are.  Office 

Bee  Sheet  12 

OvnHBAD 

Main  Office       See  Sheet  10 
Sth  Ave.  Office  See  Sheet  1 1 
Madiaoo  An.  Office 

6ee  Sheet  12 

310.  Oflieen'  SaUriea 
31L     "  liUacbei 

Non  PsoDOorm  Expemes 
Main  Office       See  Shmt  10 
Mb  Atc.  Office  See  Sheet  11 
Madison  Ave.  Office 

See  Sheet  12 

TOTAL  EXPENSES 

\ 



■| 

111 

REMARKS: 

Nari:  Sheets  9,  10,  11  and  12  are  the  same  as  abeots  2  to  6.  except  that  the  oolainDs  are  baaJod  the  same  m 
abeet  7. 

APPENDIX 


Request  for  Appropriation 

Authority  is  hereby  requested  for  an  increase  of 
-in  the  budget  for  the- 


Department,  Classification  No  .  beginning 

 192    ,  for  the  following  reasons: 


Date  192         Signed  by 

Request  granted  for  $  


Comptroller. 


A  TRUST  COMPANY  BUDGET  SYSTEM 


465 


INDEX 


Accounting, 

data  and  statistics,  252-253,  272 
department,  40,  66,  262,  293,  389 
methods,  189,  194,  249 
period,  length  of,  34,  310 
Advertising, 

appropriation,  107,  112 

report,  11 7-12 1 
budget,  106-123 

control  of,  1 19-123 

form  of,  1 18-120 

preparation  of,  116-118 
cost,  calculating,  108-111,  364 
expenditures  report,  122 
purpose,  1 1 2- 1 14 
purpose  vs.  method  of,  115 
vs.  selling  expense,  106,  283-284 

B 

Balance  sheet, 

accounts  payable,  347,  355 
assets,  fixed,  344-345.  348,  354,  356 
based  on  estimates,  7,  50,  203,  329 
bonds  payable,  348,  356 
capital  stock,  348,  356-357 
cash  estimate,  340-341,  350 
comparative,  351 
deferred  charges,  345,  355 
estimated,  333-358,  3<JO 
estimated  and  actual  compared, 
369 

forms,  339,  351,  369 
good-will,  346 
income,  accrued,  344 
inventories,  343-344,  353-354 
liabilities,  accrued,  347 
liabilities,  fixed,  356 
mortgages  payable,  348,  356,  365 


Balance  sheet — Continued, 

notes  payable,  346-347.  35^,  355. 
357 

notes  receivable,  341-342,  352 

preparation  of,  332,  340 

ratio  of  current  assets  to  current 
liabilities,  357-358 

reports,  use  of  financial,  335-337 

standard  forms,  335-372 

surplus,  348,  357,  366 
Bank  loans, 

financial  program  for,  318 
Board  of  directors, 

authority  of,  21-24 

budgetary  control  b}',  7,  48,  52-53, 
63,  287,  370 

budgets  submitted  to,  23,  53 

periodic  reports  to,  8,  24,  50,  290 
Budget  act, 

federal,  439-449 

state  (Ohio), 450-455 
Budgetary  control, 

advantages  of ,  416-424 

as   coordinating   several  depart- 
ments, 3,  12,  299,  416-423 

chart  of  procedure,  394  (insert) 

defined,  3-1 1 

educational  institutions,  430 
essential  features,  8 
federal  law,  defined,  439 
governmental  units,  426-427 
installed,  28-53,  422 
limitations  of,  421-424 
manual  on,  42,  374-395 
modern  tendency  toward,  lo-ii 
need  for,  12-27;  54 
non-commercial   enterprises,  425- 
438 

organization  for,  43-53,  375 


467 


468 


INDEX 


Budgetary  control — Continued, 

period,  length  of,  29,  34-36,  85,  308, 

310,  314,  338,  375 
popular  conception  of,  4 
program  for,  35,  41,  419,  421 
purposes,  12,  27,  35 
state  governments,  429-430 
state  university,  430-437 
trust  company,  456-465 
Budgets,  (See  also  'Tstimates";  also 
various  classes  of  budgets  under 
their  own  headings) 
committee, 

duties  of,  7,  47-49,  204,  266,  378, 

380, 394, 419-423 
members,  7,  47,  376 
periodic  reports  to,  8,  51,  187, 
204,  224,  264,  268,  2  ,0,  293, 
320, 368,  3-3 
controlling  sales,  80-81 
departmental,  contents  of,  7-8,  298, 
300 

governmental,   direct   control  of, 

45-47,  444-449 
governmental,  types  of,  439-443, 

450-455 
priority  list  used  in,  83 
revised,  81,  206,  208-209,  224,  294, 

319,  332,  338,  348,  366-367 
state  uni\'ersity,  430-437 
system  of,  11,  46,  299 
trust  company,  456-465 
types  of,  9-10,  70,  140,  202,  207-208 
Business  activities, 
administrative,  25 
coordinating,    13-17,    58-59,  299, 

420-423 
interdependence  of,  13,  54 
types  of  information  needed  on,  26, 

65 

Business  control, 

executive  corporate  group,  21 
general  ofificers',  24-25 
junior  executives',  25-26 
owner's,  21 


C 

Capital, 

additional,  6,  23,  295,  317,  348 
requirements,  analyzed,  324-328 

Cash, 

disbursements,  308-315 
receipts,  301-308 
Chart, 

budget  procedure,  394  (insert) 
graphic,  accumulated  sales  and  col 

lections,  304 
organization, 

corporation,  21 

manufacturing  business,  275,  277 
Collections, 

and  sales  chart  (graphic),  304 

period,  303-305 

report,  monthly,  321 
Comparative  balance  sheet,  351,  36) 
Comparative  profit  and  loss  state- 
ment, 363,  371 
Corporation  organization  chart,  21 
Credit, 

building  up  bank,  32 

"reserve  line,"  at  bank,  323 

D 

Department  store, 

departmental  merchandise  plan,  239 
Disbursements,  cash,  308-315 

E 

Employees, 

cooperation  with,  41-42 
demand  for,  59 

desirable  W'orking  conditions,  178- 
179 

housing  of,  171,  182,  306 
transferring,  271 
welfare,  per  capita  cost,  183 
Equipment  (See  "Plant  and  equip- 
ment ") 

Estimated  and  actual  balance  sheets, 

compared,  369 
Estimated  and  actual  profit  and  loss 

statement,  compared,. 371 


INDEX 


469 


Estimates,  (See  also  "Budgets") 
as  working  program,  7,  8,  48 
central  control  of,  393,  421 
comparing,  6,  19,  307,  369,  400 
departmental,  5,  40-41,  50,  173,204, 

223,  233,  255,  258,  291,  300,  312, 

319,  331.  338,  366-367,  421 
in  terms,  67 
items  used  in,  68-69 
"key"  items  in,  69-70 
responsibility  for  preparing,  36-38, 

71-72,  223,  262,  290,  312 
selling  expense,  need  of,  88,  312 
Executive, 
chief,  24,  47,  375,  427 
control,  centralized,  20-21 
control,  decentralized,  18,  19,  26, 

192 

cooperation  needed,  17,  41-42,  374 
departmental,  duties  of,  37,  52,  61, 
377 

general  manager,  375 

assistant  to,  376-377, 378, 380, 394 
in  charge  of  budgetary  procedure, 

7,  39.  44,  49-51,  177,  204,  262, 

289,  293,  317,  319,  368 
junior,  duties  of,  25-26 
periodic  reports  by,  8,  24,  176 
staff  assistant  as,  50-53 
Expense, 

administrative,  274,  279,  287-288, 
388 

allocation  and  business  organiza- 
tion, 280-281 

allocation  basis,  283-285 

auxiliary,  274,  286,  312 

budgets,  273-294,  299,  312,  360, 
365,  386-391,  459-463 
control  of,  289-290,  294,  387-391, 

419-423 
form  of,  291-292 

classified,  274-276,  294 

commercial,  allocating,  279-280,283 

corporate,  274,  288,  291,  312 

direct,  276-278 


Expense — Continued, 

financial,  285-286,  291  (See  also 
"Finances") 

indirect,  276-278,  285 

manufacturing  (See  "Manufactur- 
ing expense ") 

"miscellaneous,"  budget  of,  202- 
203,395 

not  to  be  allocated,  281-282 

problems,  273 

reports,  monthly,  292-294 

salesmen's,  94,  100 

shipping,  95,  97,  98,  loi 

welfare,  185 

F 

Factory  (See  "Production") 
Federal  Budget  Act,  439-449 
Finances, 

accounts  receivable,  301,  303-305, 

322,  328,  342-343,  352,  354 
bank  loans,  316-319,  325,  328,  334, 

340,  346,  350,  356,  367 
budget,  295-332,  340,  367,  391-392 
control  of,  319-321 
preparing,  264,  317-319,  330-332 
vs.  business  cycle,  328-329 
vs.  department  budgets,  300,  301 
cash  balance,  297,  303,  316,  349-352 
cash  disbursements, 

form  of  estimate  of,  312-314,  347, 
391 

items  for,  315 

methods  of  estimating,  314-315. 

331,340 
cash  period,  length  of,  322-323 
cash  receipts, 
basis  of,  303-305 

determining,  301-303,  305,  331, 
391 

sources  of,  305-307,  322 
collection  period,  303-305 
collections,  estimate  of,  319 
debts,  allowance  for  bad,  302,  343 
expenses,  disbursements  for,  312 


470 


INDEX 


Finances — Continued, 

methods  of,  32,  301-303,  330 
planning,  16,  65,  88,  233,  295-297, 

324,  330,  420,  423 
planning,  long-time  vs.  short-time,. 

297-  258 
purchases, 

merchandise,  309 
production  purposes,  310-312 
requirements,    determining  cash, 

298-  300,  324 

requirements  of,  77-78,  228,  274, 

295.317,418 
statements,  preliminary  estimates 

of,  392-393 
Finished  goods  (See  "  Production") 
Forecasting, 

based  on  statistics,  83 

defined, 3 

I 

Industrial  engineering, 

defined, 3 
Inventory,  (See  also  "Material") 
estimated,     213-215,     220,  230, 

241, 360, 410 
method  of  determining,  212,  216, 
219 

"normal,"  216,  220,  235 

periodical,  259 

perpetual,  212-217 

planning,  statistics  of  past  periods 

in, 215-216 
physical,  215-218 
report,  monthly,  407-409,  414 
Invoice, 

purchase,  classified,  232-234 

L 

Labor, 

budget,  165-177,  208,  380,  382 
control  of,  177 
form  of,  176 
preparation  of ,  173-176 
report,  monthly,  175 


Labor —  Continued, 

cost,  174,  176,  265,  310,  381 
indirect,  a  manufacturing  expense, 

173. 189,310 
pay-roll, 

budget  of,  171-173,  202 
objections   against    budget  of, 
172 

vs.  expense  budgets,  289 
requirements,  analyzing,  166-168 
requirements  vs.   production  and 

labor  policies,  169-171 
standard  rates,  168 

purposes  of,  169 
turnover,  determining,  184 
Law,  budget, 
federal,  439-449 
state  (Ohio),  450-455 
Ledger,  plant,  253-255,  258 

form,  254 
Loans,  bank, 

financial  program  for,  318 

M 

Manual  on  budget  procedure,  42,  374- 
395 

Manufacturing  business,  organization 

chart,  275,  277 
Manufacturing   expense,    (See  also 

"  Production  ") 
budget,  188-209,  208,  250,  300,  310, 

382-383 

control  of,  206 

preparation  of,  203-206 

report,  monthly,  205 
classified,  igo-192 
defined,  189-190,  274 
depreciation  as,  28 1 
distribution  of,  194-196,  202,  256, 

276, 278-279,  285 
estimated,  188,  197,  206,  382 
machine  rates,  idle  and  overtime. 

200 

machine  rates,  modified,  202 
packing  cost  as,  96 


INDEX 


Manufacturing  expense — Continued, 
requirements  determined,  192-194 
standard  rates  in,  188,  196-198 
method  of  establishing,  198-200 
vs.  production,  201 
Market, 

analysis,  61-63 

conditions  affecting  budget  period, 
33 

fluctuations  affecting  sales,  85 
Materials,  (See  also  "Labor") 
basis  of  inventory  control,  151 
budget,  154-164,  207,  310,  346,  383- 
385 

control  of,  163-164 
form  of,  160-163 
preparation  of ,  158-160 
report,  161 

vs.  purchasing  policy,  155-157 
estimate,  need  for,  145,  159,  168 
requirement,  by  commodities,  145 
requirement,  by  ratios  of  former 

peri6ds,  147-148 
requirements  r5.  inventory,  149-151 
standard  rates,  148,  158 
stores  balance,  sheet,  153 
stores  budget,  1 57,  202 
stores  vs.  expense  budgets,  289 

N 

Non-commercial  enterprises,  budget 
system,  425-438 

O 

Officers, 

general  business,  list  of,  25 
Ohio, 

administrative  code  for,  450-455 
Operations,  summary  of,  monthly,  41 1 
Orders, 

purchases,  230,  232 

implied,  classification  of,  234,  410 
Organization  charts, 

corporation,  21 

manufacturing  business,  275,  277 


P 

Planning, 

business  operations,  3-4,  329 
classified,  3 

department,  7-8,  136,  159,  166,  173, 
262 

equipment  and  personnel,  15 
estimates  needed  for,  27,  55,  210 
Plant  and  equipment, 
additions,  246,  249,  257 
betterments,  246,  249,  257 
budget,  245-272,  345,  385-386 

contents  of,  261,  264,  272 

form,  263 

preparing,  261-362,  31a 

report,  269 
charges,  capital  vs.  revenue,  250 
charges,  maintenance,  250-251,  253, 

257 

construction,  costs  of,  267-268 
depreciation,  248,  255-256,  258,  261, 
345.354 

engineer,  functions  of,  260,  262,  264 
equipment,  use  of  standard,  270-271 
expenditures, 

classified,  245-246,  266 
data  controlling,  251-253,  272 
requisitions  for,  265-267,  272 
reserve  account,  268-270 
experts,  information  by,  258-260 
plant  ledger,  253-255,  258 

form,  254 
repairs,  246-247,  254,  256,  258,  261, 

267, 273 
replacements,  246,  248,  273 
vs.  volume  of  production,  256-258 
Procedure,  budgetary, 

budgets,  branch  and  division,  370- 
372 

chart,  394  (insert) 

dates  for  submission  of  estimates 

and  reports,  394 
disadvantage  of  decentralized,  44- 

45 

first  steps  towards,  28-29 


472 


INDEX 


Procedure,  budgetary — Continued, 
"general  budget,"  370 
interdepartmental,  manual  for,  393 
manual  on,  42,  374-395 
modern  tendency  towards,  lO-ii 
outlined,  5-8 

plant  and  equipment,  executing 
budget  of,  265,  271-272 

supervisor  for,  5-6,  49 
Production,  (See  also  "Manufactur- 
ing") 

basis  of  inventory  control,  130-131 
^budget,  124-144,  379-380 

preparation  of,  139-140,  307 

relation  of  to  sales  budget,  124 
calculating,  134-135 
capacity  vs.  sales  estimate,  125-127 
control  vs.  policies,  124-125 
control,  review  and  summary  of, 

206-209 
cost,  136-138 
economical  run,  133-134 
estimate,  inventory  schedule  and, 

128-130 

finished  goods  budget,  207,  228 

report,  141,  407-409 
inventories,  monthly  report,  414 

balance  of  stores  sheet,  153 
items,  69,  86,  146,  167 
maintaining  uniform,  17 
margin  of  safety,  132-133 
period,  31,  131 
reducing,  6 

requirements  determined,  73,  127, 
258 

special  orders,  control  of,  138-139 

unit  costs  and  volume  of  produc- 
tion, report,  413 

vs.  sales,  14-15,  75,  416-417,  422 
form  of  estimate,  73 
Profit, 

estimated,  75,  87,  362 

gross,  on  sales,  362-364 

maximum  gross,  76 

net  operating,  365,  405 


Profit  and  loss, 

balance  sheet,  relation  to,  266-267 
causes  of,  15-16 
comparative  form,  363,  371 
cost  of  goods  sold,  360 
expenses, 

non-operating,  361 

operating,  360-361,  364,  367 
income,  non-operating,  361,  365 
manufacturing  expense,  as,  196,  200 
net  income,  365 
notes  receivable,  361 
reports,  control  of  financial,  368- 

370 

sales,  returns  from,  359 
statement,  213,  251,  255,  289,  32;, 

332-334,  338,  348,  352,  359-373 
contents  of  estimated,  359,  365 
preparing  estimated,  367-368 
Purchases, 

budget,  210-227 
control  of,  223-227 
report,  225 

vs.  merchandise  policy,  235-238 
data,  classified,  230-235 
deliveries  to  stock,  220-222,  226, 

228,  230,  236,  242 
estimate,  preparing,  222,  232,  242, 

292, 309 
inventory,  types  of,  212-216 
payments  for,  228-230,  309-312 

form  of  estimate,  231 
requirements,  211 
vs.  sales,  210,  310 

R 

Receipts, 

additional,  6 

estimated,  78,  307-308 
Records, 

accounting,  34,  40 

departmental,  8 

finished  goods,  135 

materials,  152-155 

objections  to  studying  past,  ij;-20 


INDEX 


473 


Records — Continued, 

plant  ledger,  253-255 

supplementary,  importance  of,  233 
Reports, 

administrative  (See  "Reports,  ad- 
ministrative, below") 

advertising  appropriation,  monthly, 
121 

advertising  expenditures,  122 
cash  disbursements,  323 
cash  receipts,  322 
collections,  321 

comparative,  27,  34,  40,  163,  1S7, 
293, 320,  400 

construction  cost,  267 

control,  use  of,  102-105,  226-227, 
272,  294 

expense  appropriation,  293 

finished  stock,  141-144 

from  sales  units,  81 

inventories,  414  (See  also  "stock" 
below  in  this  list) 

labor  budget,  monthly,  175-176 

manufacturing  expense,  205 

materials,  161 

merchandise  plan,  240 

net  profits,  405 

operations  summary,  41 1 

plant  and  equipment  appropria- 
tions, 269 

purchases,  225,  229,  232 

responsibility  for,  38-39,  262,  370 

sales,  402 

selling  expense,  103,  403 
statistical,  333 
stock,  407 

comparative,  408,  409 
unit  cost  and  volume  of  production, 

413 

used  in  purchases  budget,  242-244 
welfar"  expense,  monthly,  185 
Reportsf  administrative,  396-415 
classified,  396-397 
essentials  of  executive  reports,  397- 
401 


Reports,  administrative — Continued, 

factory  inventories,  415 

information, 

actual  performance,  398 
estimated  performance,  399-400 
past  performance,  400 

needed, 396 

net  profits,  monthly,  406 
operations,  monthly  summary  of, 
412 

production  control,  410-415 

sales  control,  401-404 

selling  expense,  monthly,  404 

stock,  monthly,  410 

summary,   monthly  comparative, 

410-412 
types  of,  401-415 
unit  costs,  415 
vs.  executive,  397 

S 

Salary  budget,  state  university,  434- 

435 
Sales, 

analysis,  63-64 

anticipated,  57-59,  132 

budget,  54-86,  207,  241,  299,  377- 

379 
campaign,  87 
data,  classified,  66-67 
estimate, 

manufacturing  business,  59-60, 
67,74 

mercantile  business,  58,  301-302 
need  for,  55-56 

revision  of,  75-78,  82,  224,  379 
threefold  basis  of,  60-65,  4^8 
vs.  inventory  requirements,  72- 
74,213 

expense  (See  "Selling expense,"  be- 
low) 

information,  54-55,  65-67 

items,  68-69,  76,  85 

office  expense,  92-93,  100,  273,  364 

orders  vs.  shipments,  82 


474 


INDEX 


Sales — Continued, 
planning,  3 
problems,  84-86 

program,  78-80,  184,  211,  230,  238, 

417,419,422 
reducing,  6,  353 
report,  402 

vs.  collections,  302-303 

chart  (graphic),  304 
vs.  plant  and  equipment,  15,  5) 
Selling  expense, 

allocation  of  "drayage,"  96 
budget,  87-105 

form,  103 

preparation  of,  101-102 
report,  403 

classified,  91 

controlling,  88-90,  389 

defined,  90-91,  274 

distributed,  276,  283,  285 

method  of  estimating,  99-101 

ratio  to  sales,  364,  406 
Shipping, 

breakage  in,  98 

expense,  analysis  of,  '.  7 

expense,  packing  and,  95,  98,  loi 
State  Budget  Act  (Ohio),  450-455 
State  university  budget  system,  430- 

437 
Stock, 

deliveries  to,  221 

finished  (See  "Inventories,"  "Pro- 
duction ") 
Stockholders, 
authority,  22,  27 

limit  of  direct  business  control,  22- 
23 

ownership  vested  in,  21 


Stores  (See  "Materials") 

Summary  of  operations,  monthly,  41 1 

T 

Transportation , 

freight  out,  expense  of,  96-97 
warehouses  and  branch  depots,  98 
Turnover, 

inventory  and,  218-220 
merchandise, 

calculation  of,  217-218 
estimating,  241 
rate  of,  362-366 
period,  length  of,  30-31 
Trust  company  budget  system,  456- 
465 

U 

Unit  costs  and  volume  of  production, 

report,  413 
University  budget  system,  430-437 

V 

Volume  of  production  and  unit  costs, 
report,  413 

W 

Welfare  expense, 
budget,  178-187 
control  of,  186-187 
form,  185 

preparation  of,  186 

report,  form,  185 
classified,  179,  186 
estimating,  181-185 
per  capita  cost  method,  182-184 
vs.  departmental  expenses,  1 80-1 81 
vs.  labor  cost,  178 


4 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 
Los  Angeles 

This  book  Is  DUE  on  the  last  date  stamped  below. 


iitC'U 

N0V281962I 


m 


Form  L9 -125A«-3,'bl  (liaieOs'lH-li 


L  008  244  390  4 


